Various memes in social media, like a finger-wagging open letter to Alan Simpson in 2010, are again kicking up about Social Security: how it’s close to bankruptcy, how politicians mismanaged the economy, and how, as a result, Congress took money out of Social Security and wasted it elsewhere.
Social Security is complex and works differently from how many assume. One of the most common misconceptions is that the program acts like a collection of savings accounts that pay interest until someone is old enough to receive benefits.
Where Social Security came from.
The history of the program goes back to the Great Depression. In 1935, President Franklin D. Roosevelt signed the Social Security Act. At that time, according to The Poynter Institute’s Politifact’s research into source data, the poverty rate for the elderly was at least 50% and may have been far higher.
One enormous reason the poverty rate of people 65 years of age and older in 2022 was 10.9%, 1.6 percentage points lower than the overall rate according to the Census Bureau, is Social Security.
The older people at that time weren’t paying into a system and saving money. From the onset, people working began to pay a tax that was used to cover the benefits for those receiving them. If it had shifted even immediately to a pay-ahead-and-save system, the first people who could have received Social Security payments after the initial eligible group would have had to wait until the 1970s to collect.
How Social Security is funded.
Like many other types of government services, special or general taxes provide the funding for Social Security. At the local level, people are taxed to provide education to children. That is true whether they have children in the system or not. If it comes from property taxes, you can be certain that landlords pass on the proportional parts of the property taxes to renters.
In the case of Social Security, there are special taxes levied on incomes. Employees and employers pay half — 6.2% each to total 12.4% for every employee. Self-employed people pay the full 12.4% by themselves. In 2025, the maximum taxable income is $176,100.
A fixed portion of the special payroll taxes go into the Old-Age and Survivors Insurance (OASI) Trust Fund, which provides for payments to individuals collecting Social Security. Additionally, the Disability Insurance (DI) Trust Fund pays monthly benefits to disabled workers and their spouses and children.
In each case, any funds not needed for current benefits are invested in Federal securities, as required by law. Over time, the Treasury pays interest and at the end term of the securities the principal, back into the trust funds. What doesn’t exist are individual accounts where taxes paid by workers and employers get stored, generating interest for them specifically.
Why are there financial problems with Social Security?
The short answer is that money has been paid out faster than money has flowed into the trust funds.
Benefits have risen over time, particularly with the automatic annual cost of living escalator. More importantly, the number of people receiving Social Security has increased as baby boomers have aged.
However, according to Stephen Goss, the Social Security Administration’s chief actuary, birth rates started falling in 1965, as MarketWatch reported. People are living longer, but forecasts on the part of the SSA have been “remarkably accurate.”
The big problem has been rising income inequality, Goss said, particularly between 1983 and 2000. (As I’ve written before, there was a major change around 1984 when cost of living started growing increasingly faster than median household incomes.)
During that 1983-to-2000 period, the best-paid 6% of people saw their incomes rise by 62% in inflation-adjusted terms. The other 94% saw incomes increase by 17%. The big portion of income gains were above the maximum taxable income level, so the needed funding weren’t available.
“This is a massive change in the distribution of earnings, and that’s what caused us to have a much smaller share of all covered earnings falling below our taxable maximum,” Goss said, as MarketWatch quoted. “This is a major component of the shortfall we’ve had.”
There is an additional factor. After the Great Recession, the Federal Reserve drastically cut interest rates, which affected the yields of short-term government securities. Yields of longer-term securities also fell drastically. The investments didn’t provide the same level of return that once beefed up the trust funds.