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Social Security Could Go Bankrupt if This Happens

By Sean Williams – May 4, 2018 at 9:21AM

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Changing one key aspect has the potential to destabilize the whole program.

Whether you realize it or not, America's most important social program is in trouble. Despite providing benefits to more than 62 million Americans, including 42.8 million retired workers each month as of March 2018, Social Security is at risk. 

Worries mount for America's top social program

According to the Social Security Board of Trustees' 2017 report, released last summer, the program is on track to begin paying out more in benefits than it's generating in revenue by 2022. That's just four years away. While there are numerous reasons this shift is under way, the major catalysts include the ongoing retirement of baby boomers from the workforce, steadily lengthening life expectancies over many decades, and growing income inequality that's allowed the well-to-do to live longer and collect higher monthly benefits than low-income workers.

Dice lying next to a piece of paper that reads, Will Your Social Security Be Enough?

Image source: Getty Images.

The real concern and uncertainty surrounds what happens 12 years later. The Trustees report projects that Social Security's Trust will have completely exhausted its roughly $3 trillion in asset reserves -- the extra cash it's built up over the past three-and-a-half decades that's currently invested in special-issue bonds and certificates of indebtedness -- by 2034. Many people view the depletion of this excess cash as a sign of the program's insolvency. In fact, 51% of nonretirees surveyed by Gallup in the summer of 2015 didn't expect to receive a monthly Social Security benefit when they retire. 

Thankfully, though, as things stand now, Social Security won't be going bankrupt anytime soon.

If nothing changes, Social Security can't go bankrupt

Social Security is funded three separate ways. The smallest contributor is the taxation of Social Security benefits at the federal level. Signed into law in 1983, single taxpayers whose adjusted gross income plus half of their Social Security benefits tops $25,000 can have half of their benefits exposed to federal ordinary income tax. For couples filing jointly, this figure is $32,000. In 1993, a second tier was added that allowed 85% of Social Security benefits to be taxed at the federal level for single taxpayers with earnings above $34,000 and couples filing jointly over $44,000. In 2016, the taxation of benefits provided $32.8 billion of the $957.5 billion collected.

The next largest contributor is the interest income earned on Social Security's asset reserves. As noted, this excess cash is primarily invested in special-issue bonds and to a lesser extent certificates of indebtedness. The average yield on these assets is about 2.9%, which in 2016 produced $88.4 billion in interest income. Of course, with the program's asset reserves expected to be exhausted in 16 years, interest income could soon disappear.

Two Social Security cards lying atop a W2 form, highlighting payroll taxes paid.

Image source: Getty Images.

But the biggest contributor, by far, is the 12.4% payroll tax on earned income between $0.01 and $128,400, as of 2018. In 2016, $836.2 billion (87.3%) of the $957.5 billion collected was derived from Social Security's payroll tax. In essence, as long as the American public keeps working, payroll tax revenue will be collected, providing revenue that can be disbursed to eligible beneficiaries. 

Understandably, this doesn't rule out the possibility of benefit cuts at some point in the future. The Trustees estimate the need for an across-the-board cut of up to 23% to current and future retiree benefits in 2034 if no additional revenue is raised. But the key point is that Social Security, when primarily funded by the payroll tax, won't go bankrupt and will be there to provide a benefit in some capacity when you retire (assuming you're eligible to receive benefits).

But if this happens, Social Security could go bankrupt

However, it's not out of the question that Social Security could face insolvency if lawmakers on Capitol Hill change how the program is funded. If the payroll tax is removed in favor of another funding mechanism, the guaranteed monthly benefit that retirees receive has the potential to become less guaranteed.

As an example, an idea was floated around in April of last year by a Republican lobbyist that would have removed the payroll tax as the program's lead generator of income and replaced it with a value-added tax on consumption. Since around 70% of U.S. GDP is dependent on consumption, the idea here is that it would lead to a steady source of revenue for the program. Eliminating the payroll tax would put about $3,100 back into the pockets of the average American household earning $50,000 a year.

The facade of the Capitol building in Washington, D.C.

Image source: Getty Images.

The problem with switching to a value-added tax would be twofold. First, it would tie Social Security to the health of the U.S. economy. If the U.S. underwent a period of economic slowing or a recession, which is inevitable, it would adversely impact how much money is collected by the program. Given that 62% of retired workers rely on Social Security for at least half of their income, any recession-based hiccups could prove devastating.

The potentially greater concern is that a value-added tax would allow the federal government to treat this income as general revenue. Items lumped in as general revenue can be apportioned annually by Congress. In other words, the federal government could easily change how much it apportions to the program from year to year, increasing or decreasing the amount to fit their budgetary needs. 

Thankfully, this idea found little to no traction in Washington. But that's not to say a future idea that could remove the payroll tax won't be implemented.

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