Trust Funds: Real and Imaginary

It is interesting that the basic framework of the U.S. unemployment compensation program was first established in the Social Security Act of 1935. Although both programs have trust funds, one is real, and one is imaginary.

Due to the COVID-19 “pandemic,” state unemployment programs were stretched to the limit in 2020 and into 2021. Let me briefly explain how these programs work.

The U.S. Department of Labor oversees the unemployment compensation program and sets broad guidelines for coverage and eligibility, but it is administered and mostly funded by the states, which vary considerably not only in the manner and degree in which taxes are levied and collected from employers to fund the system but also in eligibility requirements, benefit levels, and duration of benefits.

Unlike Social Security taxes, which are borne equally by employer and employee, unemployment taxes are paid solely by employers (except in the few states that tax employees as well). A federal unemployment tax of 6 percent is imposed on employers on the first $7,000 of taxable wages paid to each employee during a calendar year. Each state likewise assesses employers an unemployment tax, and the rates vary widely. More than half of the states also have a higher taxable wage base than that of the federal government. The Federal Unemployment Tax Act (FUTA) allows an employer to claim a credit against his federal tax liability of up to 5.4 percent for payment of state unemployment taxes.

Federal unemployment tax revenue is deposited into the Employment Security Administration Account (ESAA) within the federal Unemployment Trust Fund (UTF). Federal money pays for the costs of administering unemployment insurance programs, loans made to state unemployment insurance funds, and half of extended unemployment benefits during periods of high unemployment.

Each state’s unemployment tax revenue is deposited in state accounts within the UTF. This is what funds the states’ regular unemployment benefits. According to the U.S. Department of Labor’s annual State Unemployment Insurance Trust Fund Solvency Report, there was $75,677,289,747 in state trust fund balances at the end of 2019. Since the start of the “pandemic,” states have paid out $175 billion in unemployment benefits: when outstanding debt is taken into account, 10 states have a negative net balance in their trust funds, while 40 states have positive trust fund balances, ranging from $3,012,915 for Hawaii to $4,381,384,098 for Oregon.

These are real trust funds with real assets—unlike Social Security trust funds.

The Social Security program is funded by a 12.4 percent payroll tax (split equally between employers and employees) on the first $142,800 of an employee’s income and, to a much lesser extent, by taxes on Social Security benefits. Even though President Franklin Roosevelt claimed that Social Security tax dollars were “held in a Government trust fund solely for the social security of the workers,” not a penny of any taxes collected goes into a trust fund, a retirement account, a savings account, an investment account, or a lock box.

Instead, Social Security is a pay-as-you-go system. This means that payments to retirees come from current payments by workers into the system, not from anything that they paid into the system. There is, in fact, no connection between the taxes one pays into Social Security and the benefits one receives from Social Security. The Social Security Administration (SSA) even acknowledges that “The money you pay in taxes is not held in a personal account for you to use when you get benefits. Today’s workers help pay for current retirees’ and other beneficiaries’ benefits.”

The Social Security trust fund is just an account in the U.S. Treasury. Payroll taxes go into Treasury’s general fund to pay for government expenditures and are credited to the trust fund in the form of “special issue” U.S. securities. These securities are not tradable, are only available to the trust funds, and are only purchased with payroll taxes.

As explained by the SSA:

How are the trust funds invested?

By law, income to the trust funds must be invested, on a daily basis, in securities guaranteed as to both principal and interest by the Federal government. All securities held by the trust funds are “special issues” of the United States Treasury. Such securities are available only to the trust funds.

What happens to the taxes that go into the trust funds?

Tax income is deposited on a daily basis and is invested in “special-issue” securities. The cash exchanged for the securities goes into the general fund of the Treasury and is indistinguishable from other cash in the general fund.

Why do some people describe the “special issue” securities held by the trust funds as worthless IOUs? What is SSA’s reaction to this criticism?

Money flowing into the trust funds is invested in U.S. Government securities. Because the government spends this borrowed cash, some people see the trust fund asset reserves as an accumulation of securities that the government will be unable to make good on in the future. Without legislation to restore long-range solvency of the trust funds, redemption of long-term securities prior to maturity would be necessary.

Far from being “worthless IOUs,” the investments held by the trust funds are backed by the full faith and credit of the U. S. Government. The government has always repaid Social Security, with interest. The special-issue securities are, therefore, just as safe as U.S. Savings Bonds or other financial instruments of the Federal government.

The Social Security trust fund is nothing more than a government accounting fiction. In a nutshell, the essence of Social Security is simply this: money is taken from those who work and given to those who don’t, and yet, the vast majority of Americans still believe that retirees are entitled to Social Security benefits because they paid into the system their entire working lives.

To the contrary, four facts about Social Security should be noted.

There is no contractual right to receive benefits. The Supreme Court ruled on this decades ago.

Benefits are calculated by an arbitrary formula. Congress can change the formula at any time.

The Social Security tax is just a regular federal tax that puts money in the Treasury. Its name means absolutely nothing.

Social Security is just another federal welfare program. In fact, it is an intergenerational, income-transfer, wealth-redistribution welfare program.

This article was originally published at the Future of Freedom Foundation and is reposted here with permission.