Earlier this year, the committee in charge of the Social Security trust funds released its latest annual report detailing the financial status of the government-administered social safety net that millions of Americans rely on for income in retirement. The results weren't encouraging.
While the main $2.7 trillion trust fund continues to grow, albeit at the slowest pace in three decades, this trend is expected to reverse over the next few years, most likely around 2022 -- and just for the record, I'm referring here only to the Old-Age and Survivors Insurance program. The balance will then decline at an accelerating rate until the fund is fully depleted in 2034. At that point, the program will be deemed insolvent, and retirement benefits will have to be cut by an estimated 25%.
To help readers appreciate why this is happening, I've outlined three of the biggest threats to the Social Security system. Included along the way are charts that should aid your understanding of the coming crisis.
1. Retirement of baby boomers
If you want someone to blame for the Social Security program's impending deficit, then look no further than the generation of baby boomers.
Starting shortly after the end of World War II, the United States experienced an unprecedented surge in fertility rates. Prior to the war, fewer than 2.5 children were born to the average woman of childbearing age. But as soldiers returned home and a postwar period of prosperity took hold, this figure rocketed higher, topping out at an average of 3.68 children per woman in 1957.
As baby boomers grew older, went to college, and got jobs, they served as a potent stimulus for the economy. But now that they're retiring, their outsized share of the population is skewing the demographics of the U.S. toward retirees.
2. The ratio of workers to retirees
The problem with an aging population from the perspective of the Social Security program is that it distorts the relationship between the number of workers paying into it and the number of retirees drawing benefits from it. Indeed, this is inevitable in any pay-as-you-go system facing similar demographic trends.
As you can see in the chart above, in 2000, the ratio of workers to beneficiaries was 4.02. By 2013, it had dropped to 3.51. And by 2040, it's projected to fall all the way down to 2.43.
3. Receipts vs. expenditures
Because of these trends, the Social Security retirement program is already paying out more in benefits than it receives from payroll taxes. In the most recent fiscal year, the system took in $621 billion in payroll taxes while total expenditures added up to $680 billion.
Given this, how is it possible, as I asserted at the outset, that the main Social Security trust fund continues to increase in size? The answer is that the growing divide between receipts from payroll taxes and expenditures has thus far been offset by other sources of income.
In 2013, the system earned $123 billion in income from other sources. A total of $98 billion was interest income from its $2.7 trillion portfolio of government securities; $21 billion came from income taxes assessed against current Social Security payments; and $4 billion was the result of various intergovernmental transfers.
Should you sweat the coming Social Security crisis?
Unless you're independently wealthy -- in which case, my hat goes off to you -- the solvency of the Social Security system is something you should care deeply about, if for no other reason than the fact that it serves as the primary source of income for a large share of retirees today.
That being said, this isn't the first time we've faced a crisis like this. The situation was even bleaker in the early 1980s, when the fund was projected to become insolvent by 1983. That obviously didn't happen, thanks to policy changes that ushered in three decades of annual surpluses.
While it seems unlikely that lawmakers could muster a similarly dramatic turnaround today, the good news is that we don't need drastic action. Even relatively minor tweaks would suffice to stem the tide of future insolvency. And it's for this reason, as well as the fact that the retired population is a highly coveted voting block, that it's probably safe to assume Social Security isn't going anywhere anytime soon.