Social security: It’s more broken than you think

December 15, 2011, 3:00 PM UTC

FORTUNE — You know that life is getting very strange when something that you proposed as a joke becomes national economic policy. That’s what has happened to an idea I tossed out years ago, in one of my more sarcastic moments, when I was arguing with people about the Social Security trust fund.

I had figured out that despite looking impressive (current size: $2.6 trillion), the trust fund, which owns nothing but Treasury securities, would be of no financial value when Social Security began running cash deficits.

In fact, we’re now seeing the problem. The trust fund is currently redeeming securities to cover its cash shortfall, and the Treasury has to borrow money from investors to get cash to pay the trust fund so the trust fund can pay Social Security beneficiaries. In other words, the financial position of the government as a whole is no better than it would be if there were no Social Security trust fund.

When I broached this idea, I was assailed by people arguing that Social Security benefits were totally secure as long as the trust fund had a positive balance. So, sarcastically, I suggested that we could “solve” Social Security’s funding problems by having the Treasury deposit a high-yielding $10 trillion bond into the fund. That way, the trust fund would always have a positive balance.

Now, heaven help us, the idea of creating trust fund bonds out of thin air—rather than having the fund buy them with cash paid into it by workers and employers—has become national policy. This year, the Treasury is depositing about $105 billion of securities into the trust fund to make up for the taxes Social Security won’t collect because workers are paying only 4.2% Social Security tax on “covered wages” of up to $106,800, rather than the normal 6.2%. Next year, assuming there’s another tax cut, the Treasury will put in more bonds.

It sounds like magic. The trust fund is the same size it would otherwise be, and people who are employed have more cash to spend. Isn’t life grand?

Sorry to be a Grinch, but there’s a problem with this. If reduced Social Security payments continue indefinitely, as tax cuts seem to in this country, it will undermine the moral legitimacy of the trust fund.

It’s one thing to say that workers have paid Social Security tax for decades and are claiming benefits that they’ve earned, and that it’s perfectly okay if the government has to borrow to validate those claims. In fact, that’s what I think. But it’s a whole other thing to just plunk securities into the fund, then expect my kids to pick up the tab for validating those securities and paying my benefits.

“Social Security has a special political status because people believe it’s not welfare, that they paid for their benefits in some way,” Chuck Blahous, one of Social Security’s public trustees, told me in an e-mail. “This policy threatens that status. When we cut the payroll tax and funnel general revenues into Social Security, we shift the costs of benefit payments from program participants to general income taxpayers—and we sever the link between contributions and benefits.”

Blahous and I have sparred for years because he’s in favor of private Social Security accounts and I consider that a terrible idea. But he’s got this moral issue totally nailed.

Even if you believe that cutting Social Security taxes is good economic policy, which it probably is, there’s a more efficient way to do it. Rather than cutting 2% from all wages subject to Social Security (up to $110,100 next year), we could cut 2% on only the first $50,000 of covered wages. Workers would get up to $1,000, a nice round sum. It would cap the benefit to high-earning types like me, who don’t need the tax cut and don’t spend it. I got $2,136 this year, and stand to get $2,202 if there’s a 2% cut next year.

As for the trust fund: maybe I should hunt up the mock $10 trillion Social Security bond that a former Fortune colleague created for me in 2009. By 2013, Congress might order the Treasury to use it.