If you're not worried about the state of Social Security, you should be.
According to the newest Board of Trustees report, released in early June, America's most important social program is expected to hit an unwelcome inflection point in 2018. For the first time since 1982, the year before the Reagan administration passed the last major overhaul of the program, Social Security is expected to expend more than it generates in revenue.
Social Security has big problems (but bankruptcy isn't one of them)
On the bright side, we're only talking about a $1.7 billion net cash outflow relative to $2.89 trillion in asset reserves. But the bigger issue is that these outflows are expected to grow in size very rapidly in 2020 and beyond. Should Congress fail to generate any additional revenue for the program, or to cut expenditures, Social Security's excess cash is projected to be completely depleted by the year 2034.
Now, here's where confusion usually sets in. Burning through all of the program's excess cash doesn't mean Social Security is bankrupt. It simply means that the program has none of its extra cash left over after 35 years of running a net surplus. It will continue to generate a healthy amount of noninterest income from its 12.4% payroll tax on earned income, as well as through the taxation of benefits. Or, put plainly, payments will continue for eligible beneficiaries.
However, the depletion of the program's asset reserves is indicative that the existing payout schedule isn't sustainable. Without any excess cash, the Trustees have estimated that an across-the-board reduction in benefits of up to 21% may be needed by 2034 to sustain payouts through 2092, without any further cuts. The prospect of a 21% haircut to benefits isn't something that the 62% of aged beneficiaries who rely on Social Security for at least half of their monthly income want to see come to fruition.
Thus we have our dilemma: Social Security isn't going bankrupt, but it's on pace to run a $13.2 trillion cash shortfall between 2034 and 2092 if lawmakers do nothing.
President Trump's indirect Social Security "fix"
The solution, according to President Donald Trump, is to do nothing directly to the Social Security program. Rather than passing amendments that would adjust the payroll tax or reduce the long-term benefits of program recipients, Trump has long-touted focusing on economic growth as a means to keep Social Security solvent. This is why passing the Tax Cuts and Jobs Act was priority No. 1 for the president.
The program has three sources of funding. The two smaller sources are the interest income earned on its asset reserves and the taxation of benefits, which respectively generated $85.1 billion and $37.9 billion last year out of the $996.6 billion collected. The majority of revenue ($873.6 billion) is derived from a 12.4% payroll tax applied to earned income. Trump's thesis is that if more people are employed, and income and wages are rising, higher payroll tax revenue collected will be a net positive for Social Security.
Truth be told, the president may actually be right in 2018 and prove the Trustees wrong. According to recently revised figures, second-quarter GDP grew a very robust 4.2%. Along with inflation ticking higher since the beginning of the year, it signals that workers have more wage power than they've had in a long time -- and higher wages are a key component to an increase in payroll tax collection. Since Social Security was only expected to expend $1.7 billion more than it collects in 2018, per the intermediate-cost model, it's not out of the question that higher-than-expected payroll tax collection keeps the program in a net cash surplus in 2018 and possibly even 2019.
Trump's latest comment suggests he's ignoring the bigger picture
Last week, at a political rally in Montana, Trump doubled down on his Social Security game plan. Though rarely mentioning the program since becoming president, Trump said, following claims that Democrats would "destroy your Social Security," courtesy of RollCall.com:
I'm going to save your Social Security. We're not touching your Social Security ... Remember what I said [during the 2016 presidential campaign]: growth. growth will take care of it.
While Trump may be proven right in 2018 and 2019, his shortsighted view of economic growth appears to demonstrate a genuine lack of understanding for the demographic changes going on in plain view with Social Security. Those demographic changes include increased longevity since the inception of the program, an increase in eligible beneficiaries as baby boomers reach their claiming age (62), and growing income inequality that's allowing the wealthy to live substantially longer than the poor, as well as claim a bigger benefit check for an extended period of time. Economic growth isn't going to alter these ongoing demographic shifts.
Even more glaring is the fact that the U.S. economy naturally cycles from peak to trough. The Federal Reserve and federal government can do whatever they want with monetary and fiscal policy, respectively, but there's absolutely no way to permanently prevent recessions from happening. In other words, there's only so long the U.S. economy can grow at a 3% to 4% rate -- and when it stops, Trump's thesis that growth alone is all that's needed to fix Social Security will be proven wrong.
Direct solutions are needed to address Social Security's long-term problems, but neither party wants to risk losing their elected seats by passing legislation that causes some group of individuals to lose. And the fact of the matter is that every solution to Social Security has a loser. Whether it's the rich, future generations of workers, or some other group, not everyone wins with Social Security reform. But if Congress wants to right the ship for the long-term, it's going to have to make some tough choices sooner rather than later.
The Motley Fool has a disclosure policy.