There's perhaps no social program in the U.S. that's relied upon more than Social Security. With zero disrespect to Medicare, which primarily helps to partially cover big-dollar medical expenses for seniors during their golden years, no social program does more than Social Security.
According to the Social Security Administration, more than 3 out of 5 current retirees lean on the program for at least half of their monthly income. Then there's the analysis from the Center on Budget and Policy Priorities, which finds that Social Security income is responsible for keeping 22.1 million beneficiaries above the federal poverty line, including 15.1 million retired workers. It's simply that important.
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Surprise! The U.S. economy can play an important role in Social Security's health
But what you may not realize is that Social Security's well-being is also tied to the health of the U.S. economy. Because of the various ways income is generated for the program, an expanding or contracting economy can have positive or negative effects on Social Security. Here are three ways the condition of the U.S. economy can influence Social Security.
1. The payroll tax
If we were to create a hierarchy of importance in terms of generating revenue for Social Security, the 12.4% payroll tax on earned income would be on a pedestal that's miles above everything else. Of the $996.6 billion in income collected last year by Social Security, the payroll tax was responsible for $873.6 billion. It's almost single-handedly the reason Social Security can't go bankrupt.
The 12.4% payroll tax is applied to earned income (i.e., wage income, interest, and dividends, but not including investment and capital gains) of up to $128,400, as of 2018. The reason there's a maximum taxable earnings cap tied to the payroll tax is because there's also a maximum monthly retirement payout of $2,788 at full retirement age. This cap does increase most years in step with the National Average Wage Index.
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Since the payroll tax is taken directly out of workers' paychecks, or is paid via estimated taxes by the self-employed, the amount of income that workers bring in each year, can be a positive or negative for the program.
For instance, the passage of the Tax Cuts and Jobs Act in December is expected, by President Trump, to help create jobs and push wages higher over the long run. Higher wages and income would presumably lead to more payroll tax being collected, which is a positive for Social Security. In fact, the estimated 4.2% GDP growth in the second quarter might be strong enough to ensure that Social Security doesn't suffer through its first net cash outflow in 36 years.
On the flip side, a contraction or recession could slow or reverse wage growth, leading to a decline in payroll tax collection.
2. The taxation of Social Security benefits
The only other means of noninterest income for Social Security is the taxation of benefits. Last year, taxing Social Security benefits generated $37.9 billion for the program.
Introduced in the Amendments of 1983, and going into effect in 1984, the taxation of Social Security benefits was originally a means to generate extra revenue from well-to-do households. When passed, it allowed the federal government to tax up to half an individual's Social Security benefits if their adjusted gross income (AGI), plus one-half of their benefits, exceeded $25,000. For couples filing jointly, this figure is $32,000. In 1993, a second tier was added by the Clinton administration allowing 85% of an individual's or couple's benefits to be taxed if exceeding $34,000 or $44,000, respectively.
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The interesting thing about the taxation of benefits is that these income thresholds have never been adjusted for inflation. Thus, a tax that once impacted about 10% of all senior households now affects 56% of senior households, according to The Senior Citizens League.
Similar to the payroll tax, but to a far lesser degree, the taxation of Social Security benefits can be impacted by the well-being of the U.S. economy. If the economy is strong, higher AGIs would be expected to lead to more beneficiaries having to pay tax on some portion of their Social Security benefits. Conversely, a weaker economy, and therefore lower AGIs, would result in less tax being collected on Social Security benefits.
3. Interest income on the program's asset reserves
Even Social Security's only form of interest income can be indirectly impacted by the health of the U.S. economy.
Since the last major overhaul of the program in 1983, Social Security has collected more revenue than it's expended every year. This has allowed it to build up almost $2.9 trillion in asset reserves. Of course, the program isn't simply sitting on nearly $2.9 trillion in cash in a locked vault. By law, the program's excess cash is invested in special-issue bonds and certificates of indebtedness. At last check, the average yield across its many bonds and maturities was about 2.9%. This is what allowed Social Security to generate $85.1 billion in interest income in 2017.
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So, how does the U.S. economy affect the program's interest income, you ask? Namely, by impacting how the nation's central bank, the Federal Reserve, responds to the U.S. economy. In a strongly expanding economy, the Fed tends to tighten monetary policy by raising its benchmark fed funds target rate. This has the effect of increasing yields on interest-bearing assets, therefore leading to more interest income for the Social Security program. On the other hand, a weak economy could elicit a more dovish approach to monetary policy and lower lending rates, which would mean less interest income for the program.
So, you see, the well-being of the U.S. economy is more important than you probably realized for Social Security.
