For senior citizens, there's arguably no social program more important during their retirement than Social Security. Even though the average retired worker receives only $1,363 a month as of January 2017, this check is nonetheless counted on by more than three-fifths of all retired workers for at least half of their monthly income.
Unfortunately, this vital source of income isn't on the best footing. Despite more than 41 million retired workers currently depending on Social Security monthly (and this figure is only expected to grow as baby boomers retire), the program is heading toward disaster.
Social Security's looming $11 trillion shortfall
According to the 2016 report from the Social Security Board of Trustees, the program will begin to pay out more money than it's bringing in via payroll taxes, interest, and the taxation of benefits by 2020. That's just three years from now. More importantly, the Trustees have estimated that Social Security's more than $2.8 trillion in spare cash, which is invested in special-issue bonds and, to a lesser extent, certificates of indebtedness, will be exhausted by 2034. Overall, Social Security's long-term shortfall has been pegged at more than $11 trillion.
The partial good news here is that if Social Security's spare cash is depleted, the program will survive. Since Social Security generates most of its revenue from payroll taxes (officially known as FICA taxes), and they are collected from working Americans, there will always be revenue coming into the program as long as people keep working.
But the bad news is that the current benefit payouts may be unsustainable. The report suggests that an across-the-board benefits cut may be needed to sustain payouts through the year 2090. While getting something is obviously better than getting nothing, a 21% cut in benefits is one that a number of retired workers may not be able to cope with.
This leaves lawmakers on Capitol Hill with a tough decision: raise revenue, cut benefits, or enact some combination of the two?
Republicans favor moving to the chained CPI
One of the more popular solutions to fix Social Security among Republicans, who currently control both houses of Congress, involves adjusting how inflation is measured each year.
Right now, Social Security's cost-of-living adjustments (COLA) are tied to the Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W. The CPI-W takes into account the change in price for a predetermined basket of goods and services. The average CPI-W reading from the third quarter of the previous year serves as the baseline measurement, while the average CPI-W reading from the third quarter of the current year serves as the comparison. If the CPI-W falls year over year, Social Security beneficiaries receive no increase in their benefits (essentially a 0% COLA) the following year. But, as is often the case, if the CPI-W increases one year to the next, beneficiaries receive the percentage difference, rounded to the nearest 0.1%, the following year.
Some Republican lawmakers have suggested ditching the CPI-W in favor of the chained CPI. Like the CPI-W, the chained CPI measures the change in price for a predetermined basket of goods and services. But there's one big difference. The chained CPI takes into account a behavior known as substitution that the CPI-W does not. Substitution involves the idea that consumers will trade down to a less expensive good or service if the price of another good or service increases too much in price. Some lawmakers believe it'll therefore be a more accurate reflection of the inflation that consumers are facing, as well as their buying habits.
But since substitution implies that the chained CPI will grow at a slower pace than that of the CPI-W, it also means that seniors would see a smaller "raise" each year if the chained CPI were used.
The chained CPI means a big cut in Social Security benefits for seniors
Just how much less would seniors receive if the chained CPI were used in place of the CPI-W? While the bulk of the effects would come over multiple years and decades, Social Security and Medicare policy analyst Mary Johnson of The Senior Citizens League, a nonpartisan group that represents seniors in the U.S., found a pretty sizable impact on the wallets of beneficiaries in the future.
According to Johnson's calculations, based on a retired worker earning an average of $1,245 per month as of 2017, the chained CPI would lead to a little more than a $100-per-month reduction after 25 years (a 4.6% benefits cut) and a $136 cut in benefits after 30 years (or 5.5% according to Johnson). On an annual basis, a $136 monthly reduction in benefits works out to more than $1,600 a year less in payouts than under the CPI-W after 30 years.
Admittedly, the chained CPI could be very difficult to pass in Congress, because it's a measure that would affect all current and future retirees. President Trump pledged that he wouldn't touch Social Security during his campaign, and adjusting the COLA measure would certainly break that promise.
Nonetheless, the chained CPI has been a regularly touted solution designed to ease some of the coming pressure on the Social Security program. It would be a clear negative for current and future retirees, but given the magnitude of the program's upcoming cash shortfall, it may be necessary. Only time will tell.
The Motley Fool has a disclosure policy.