Social Security Still in Good Shape - Analyst Blog - Goldman Sachs Group (NYSE:GS), Morgan Stanley (NYSE:

This morning the annual report on the Social Security trust fund was finally released (it normally comes out in April). To read it in full

see here

, but a word of warning -- it's very long.

Here are the key findings:

“The projected point at which the combined Trust Funds will be exhausted comes in 2037 -- the same as the estimate in last year’s report. At that time, there will be sufficient tax revenue coming in to pay about 78 percent of benefits.
The projected point at which tax revenues will fall below program costs comes in 2010. Tax revenues will again exceed program costs in 2012 through 2014 before permanently falling below program costs in 2015 -- one year sooner than the estimate in last year’s report.
The projected actuarial deficit over the 75-year long-range period is 1.92 percent of taxable payroll -- 0.08 of a percentage point smaller than in last year’s report.
Over the 75-year period, the Trust Funds would require additional revenue equivalent to $5.4 trillion in present value dollars to pay all scheduled benefits.
Income including interest to the combined OASDI Trust Funds amounted to $807 billion ($667 billion in net contributions, $22 billion from taxation of benefits and $118 billion in interest) in 2009.
Total expenditures from the combined OASDI Trust Funds amounted to $686 billion in 2009.
The assets of the combined OASDI Trust Funds increased by about $122 billion in 2009 to a total of $2.5 trillion.
During 2009, an estimated 156 million people had earnings covered by Social Security and paid payroll taxes.
Social Security paid benefits of $675 billion in calendar year 2009. There were about 53 million beneficiaries at the end of the calendar year.
The cost of $6.2 billion to administer the program in 2009 was a very low 0.9 percent of total expenditures.
The combined Trust Fund assets earned interest at an effective annual rate of 4.9 percent in 2009."

There is a huge amount of hysteria in the country that says that Social Security is nothing but a ponzi scheme and is about to go bankrupt. This is simply not true, and is mostly being propagated by those who would love to see Social Security turned over to Wall Street. Doing so would put the retirement security of millions of Americans into grave danger.

Just think of what would have happened if a big part of the Social Security assets had been in the hands of Lehman Brothers or even

Morgan Stanley

(

) or

Goldman Sachs

(

) two years ago.

The overhead costs to administer the program are exceptionally small. Yes, in this case, the government is more efficient than the private sector, and not just marginally. Starting in 1982 with the Greenspan Commission, Social Security recognized the demographic time bomb posed by the "baby boom" and subsequent "baby bust." As a result, the idea was that people would pay in more than required for Social Security to run on a pay-as-you-go basis (which is how it was run up until that point). The extra funds would go into a trust fund. That trust fund now holds $2.5 Trillion.

So how is that money invested? It is invested in the safest assets around: T-Notes and Bonds. The government holding its own liabilities is a bit strange, and that is where the claim that the Social Security trust fund is composed of nothing but “worthless IOUs” comes from. However, if that is true, then it is equally true that the assets of a T-bond fund run by Vanguard or PIMCO are also composed of worthless IOUs.

In nominal terms, as long as the liabilities of the government are denominated in dollars, the government cannot default. That is true if the liabilities of the government are held by PIMCO, or the Chinese, or the Social Security Trust Fund.

However, the growth of the Social Security Trust fund was used to paper-over the true size of the deficits that were being run by the federal government. The budget deficit numbers that are routinely quoted in the press are for the total, both including Social Security and the normal operations of the government.

If Social Security were kept off to the side, and we just looked at how much money was being raised by the government through things like income tax (but excluding the Social Security payroll tax) and how much it was spending on normal operations (and excluding Social Security benefit payments), the deficit under the Bush Administration would have averaged about $200 billion a year more than it was reported.

Essentially, the higher Social Security taxes -- that were supposed to be put aside to pay for people's retirement in the future -- were used to finance the tax cuts of 2001 and 2003. Those tax cuts overwhelmingly benefited the people with the highest incomes. Social Security taxes, on the other hand, are assessed on the very first dollar of income earned, but stop once you have earned about $100,000 for the year.

The Pete Peterson Argument

There is a movement that is primarily being pushed by Pete Peterson, a former Nixon Cabinet official and hedge fund billionaire to claim that Social Security is in deep trouble because come 2037, the trust fund will have run out, and Social Security will have to return to its pay-as-you-go method (the way it was run from 1936 to 1982). Returning to the pay-as-you-go method would result in a 22% cut in the then-scheduled benefits in 2037.

However, 78% of those benefits will probably be bigger in real terms than are the benefits current retirees are getting. That hardly sounds like an urgent crisis to me. Yes, due to the recession, Social Security tax collections are down (it is, after all, a payroll tax, and thus falls when payrolls fall). Benefit payments are also up, since many people who are in their early 60’s and have lost their jobs realize that their prospects of getting a new job are bleak and have elected to take early retirement.

Thus the system has had to dig into some of the interest the trust fund is generating, rather than letting it compound. As the baby boomers start to retire, by 2015 current taxes will no longer cover current outlays. In other words, at that point the system will on a permanent basis have to first use the accumulated interest to make payments and then start to dig into principal.

Because of this, Peterson and his allies want to start making deep cuts in benefits starting now. The deficit commission that President Obama set up has several people on it who are in the Peterson camp.

Remember that Social Security has its own dedicated revenue stream. It is only because of this that it is possible to talk about it having a deficit or going bankrupt. We do not apply that standard to any other government program. If we did, we would have to conclude that the Pentagon is running a $800 billion a year annual deficit and is bankrupt.

We don’t do that, and we fund national defense out of general revenues. The Social Security system has been lending money to the general revenues side of the government for every year since 1983. Now, supposedly, we have a crisis because it is going to start to get paid back in a few years.

A little bit of tweaking is all that is needed to extend the life of the trust fund. The most obvious place to start would be to gradually raise the level at which the payroll tax is no longer collected. Right now it goes up with inflation. If we were to change that to 3x the rate of inflation, the system would quickly become solvent far beyond 2037.

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.

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