Social Security is arguably the most important social program in this country. Every year, 21.7 million Americans are lifted out of poverty solely because of their monthly Social Security payout, according to the Center on Budget and Policy Priorities.
It's also a program the vast majority of Americans will lean on, to some degree, during retirement. National pollster Gallup found that 85% of nonretirees surveyed in April 2021 expect to rely on Social Security as a major or minor source of income to make ends meet in their golden years.
Yet, for as successful as Social Security has been for decades, it's not without its own set of serious financial concerns.
Image source: Getty Images.
Social Security hasn't done this in four decades
Just as investors can review a publicly traded company's income statement and balance sheet to gain an understanding of how much revenue a company is bringing in and where those dollars are going from a cost perspective, Social Security's "balance sheet" is published annually.
Every year, the Social Security Board of Trustees releases a lengthy report that examines every facet of the program. This includes complete data on how much revenue Social Security generated from its three income sources -- the payroll tax, the taxation of benefits, and interest income -- and how many of those dollars were funneled into payments and administrative costs.
Since the Social Security Amendments of 1983 were passed by Congress and signed into law by then-President Ronald Reagan, the program has been building up its cash reserves. This is to say that Social Security has consistently brought in more revenue every single year than it's paid out. Between 1982 and 2020, Social Security's asset reserves ballooned from approximately $25 billion to $2.91 trillion.
But this trend has shifted. Although the 2022 Board of Trustees report won't be published for at least a few more months, the Social Security Administration does update its investment holdings on a monthly basis. The program's asset reserves are required by law to be invested in special-issue bonds, like U.S. Treasury bonds. Between the end of December 2020 and the end of December 2021, the total investments held by Social Security declined by more than $31 billion. That's the first cash outflow for Social Security since 1982.
Worse yet, these outflows are only slated to get worse. Based on the intermediate-cost model (i.e., the projection the Board of Trustees believes is likeliest to occur), Social Security's cash outflow could shrink the program's asset reserves to just $1.34 trillion by 2030.
Image source: Getty Images.
Social Security has a laundry list of shortcomings
You're probably wondering how such a successful social program can be turned on its head. The answer lies with a long list of demographic shifts.
To begin with, baby boomers have been retiring from the workforce for a decade. Even though their exit from the labor force was expected, it's been weighing down the worker-to-beneficiary ratio. There simply aren't enough new workers entering the labor force to offset those retiring.
We're also living longer, which is a bit of a two-edged sword for Social Security. While living longer is a positive in that we get to spend more time with our family and friends, it's a strain on a program which wasn't designed to pay retired workers for multiple decades. Since 1950, the average life expectancy in the U.S. has risen by 11 years to 79.
As life expectancy slowly climbs, U.S birthrates plunged to a record low in 2020. Though the coronavirus pandemic has, undoubtedly, weighed on the prospects of bringing children into the world, birthrates had been falling precipitously for a decade leading up to the pandemic. Everything from waiting longer to get married and easier access to contraceptives to higher economic costs have pushed birthrates lower.
Immigration is also an issue; but perhaps not in the sense you might be thinking. Social Security is reliant on legal immigration into the U.S. to bolster long-term payroll tax collection. Since most legal immigrants are young, they'll spend decades in the labor force before collecting a retirement benefit of their own. However, net legal immigration into the U.S. has been roughly halved over the past 25 years.
Even income inequality is a reason for Social Security's shortcomings. The 12.4% payroll on earned income (wages and salary, but not investment income) accounts for the lion's share of revenue collected by Social Security. However, this payroll tax has a cap of $147,000 in 2022.
For the 94% of working Americans earning less than $147,000 annually, they'll pay into the program with every dollar they earn. Meanwhile, the remaining 6% won't owe any payroll tax above $147,000 in earned income. In 2016, an estimated $1.2 trillion in earned income escaped taxation due to this cap, according to the Social Security Administration. One can only imagine this figure is even higher as of 2022.
Image source: Getty Images.
Things are going to get worse before they get better
But the scariest aspect of Social Security's financial situation is that it'll almost certainly get worse before it has any chance of improving.
Lawmakers in Congress are well aware of Social Security's numerous shortcomings. In fact, dozens of proposals and bills have been offered on Capitol Hill over the past decade. Unfortunately, the two prevailing parties in Washington aren't close to an agreement as to how best to fix Social Security. With each party believing they have the superior solution, neither has been willing to cede an inch or find common ground with their opponent.
Historically, lawmakers have waited until the 11th hour to resolve issues with Social Security. The aforementioned Amendments of 1983 were passed with bipartisan support. However, these changes were the result of the program being less than a year from exhausting its asset reserves. The 2021 Board of Trustees Report estimates Social Security will exhaust its collective asset reserves by 2034.
Worst of all, the longer Congress waits to act, the costlier Social Security is going to be to fix. The well-to-do and average working American may eventually face a hefty increase in their payroll tax obligation to right Social Security's sinking ship.
