According to the just-released 2017 Social Security Trustees' report, Social Security brought in $35 billion more than it paid out, and now has a whopping $2.85 trillion in reserves in the OASDI Trust Funds. Despite this surplus, the program is still expected to run out of money in 2034, at which point it will only be able to pay out about three-fourths of promised benefits. Here's why Social Security's financial condition is expected to deteriorate rapidly over the next 17 years and what could be done about it.
Social Security ran a surplus in 2016, and is expected to do so for five more years
In 2016, Social Security's income was $957 billion, and its total expenditures including paid benefits and administration costs came to $922 billion, which resulted in the $35 billion addition to the reserves.
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Although the $836 billion Social Security collected through payroll taxes wasn't enough to cover the program's costs, an additional $33 billion was brought in through the taxation of benefits and another $88 billion came from the interest earned on the existing reserves.
What's more, the program is expected to operate at an overall surplus all the way through 2021, so we should see the $2.85 trillion stockpile of reserves continue to grow for the next five years. Social Security's reserves are invested in special government bonds, which earned an effective interest rate of 3.2% in 2016, so you might think that Social Security is in good financial shape. And you would be right -- for now.
Here's the problem
Starting in 2022, the total annual cost of Social Security is expected to exceed the program's income. At this point, it will become necessary to tap into the reserves held in the OASDI Trust Funds in order to continue paying promised Social Security benefits.
Basically, the American population is aging. The large baby boomer generation is reaching retirement age, and people are generally living longer and longer lives.
To put some numbers behind this statement, consider that between 1974 and 2008, there were between 3.2 and 3.4 workers paying into Social Security for every person collecting a benefit. By 2016, this ratio had fallen to 2.8 workers per beneficiary. In 2035, when baby boomers will be mostly retired, this is projected to fall to just 2.2-to-1. Simply put, not enough people will be paying in to the program to support the people who will depend on it for income.
How can we fix it?
In a nutshell, there are only two ways to fix the problem. We can cut benefits, which can take the form of a higher full retirement age, lower benefits for high earners, or across-the-board cuts, just to name a few possibilities.
Or we could increase taxes to combat the expected deficits and keep the program viable over the long run without reducing Social Security benefits. The report estimates that the 75-year actuarial deficit for the OASDI Trust Funds is equal to 2.83% of taxable payroll. Since half of the Social Security payroll tax is paid by employees, and half by employers, this implies that by raising the payroll tax rate by 1.415% for employees and their employers, we could solve the funding problem.
Of course, this is a simplified solution to a complex problem. For starters, it doesn't account for the phasing in of such a tax increase. Most proposed solutions involve a tax increase that's phased in over a number of years. Doing so would require an even more dramatic increase. Additionally, an increase in the payroll tax rate is only one potential tax-related solution. We could also increase, or remove, the cap on taxable payroll, which is $127,200 in 2017. We could do a combination of the two, or a compromise that consists of a combination of tax increases and benefit reductions.
The exact reform package that will ultimately be implemented (if any) is anyone's guess at this point, but the bottom line is that there is still time to fix the problem while Social Security is still on firm financial footing. The longer we wait, the more painful the fix could be.
