Social Security, our nation's most valuable social resource, will soon face its biggest challenge since being signed into law more than 84 years ago.
According to the 2019 Social Security Board of Trustees report, the program responsible for supplying a monthly benefit check to 63.8 million people each month (70% of which are retired workers) is set to hit an unwanted inflection point in 2020. Namely, after more than three decades of collecting more revenue than the program expends each and every year, Social Security is forecast to outlay more than it brings in next year.
Although this net-cash outflow will be marginal at first -- an estimated $4.3 billion -- relative to the $2.9 trillion currently in the program's asset reserves, these annual outflows are expected to grow rapidly in size over the next decade. A decade from now, Social Security is projected to burn through $747 billion of its asset reserves, and there is a combination of five factors to blame for this imminent cash exodus.
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1. We're living longer
On the surface, increased longevity is great news. Being able to live longer means the average American has more time to spend with their friends and family, as well as pursue the hobbies they enjoy. But there's a downside to increased longevity for the Social Security program that most folks have probably overlooked.
When Social Security was signed into law in 1935, the average life expectancy at birth for men and women was 59.9 and 63.9, respectively. As of 2017, the average life expectancy at birth for all Americans (men and women, combined) is 78.6 years. In 84 years, life expectancy at birth in the U.S. has risen by almost 17 years for the average American. Comparatively, Social Security's full retirement age -- i.e., the age at which a worker becomes eligible for 100% of their monthly payout, as determined by their birth year -- has risen by a mere one year and six months. By 2022, it'll have risen just two years, from age 65 to 67, over the span of 87 years.
The result of not raising the full retirement age, or in some way indexing it to longevity, is that the typical retired worker, aged 65, is on track to receive a payout for 20 additional years. Social Security was never designed to support retirees for multiple decades, and it's clearly weighing on the program.
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2. Baby boomers are leaving the workforce in growing numbers
I hesitate to use the word "blame" here, because none of us can be blamed for when we were born. However, there's no denying that one of the reasons Social Security is in such a bind is because baby boomers (traditionally, persons born between 1946 and 1964) are leaving the workforce in greater numbers.
Following the end of World War II, birth rates in the U.S. soared to record levels. Since the program generates most of its income from the payroll tax on earned income, these "boomers" provided a significant boost to Social Security's revenue collection for decades. But this one-time benefit for Social Security is soon to be its crux.
As boomers leave the workforce, it's up to new entrants in the labor force to provide the necessary income (via payroll taxes) to support these retirees. Unfortunately, with birth rates have long since leveled off following the aforementioned post-World War II boom, there simply aren't enough new workers entering the labor force to keep the worker-to-beneficiary ratio stable. As this ratio falls, it becomes increasingly harder to support a growing base of beneficiaries.
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3. Dovish Fed policy has hindered interest income
The Federal Reserve is our nation's central bank, and its primary task is to control monetary policy and ensure the stability of the U.S. economy. For example, during the Great Recession a little over a decade ago, the Fed wound up lowering its federal funds rate to an all-time low of 0% to 0.25%, and it purchased Treasuries and mortgage-backed securities to stabilize the economy and housing market.
To many, the Fed is an economic savior. To Social Security, it's been a hindrance. That's because the Fed can influence interest rates and bond yields, and keeping its fed funds rate at a record low for seven full years completely sapped the Social Security program of its interest-earning power.
You see, Social Security's aforementioned $2.9 trillion in asset reserves is required by law to be invested in special-issue bonds and/or certificates of indebtedness. These assets provide interest income to Social Security, with $83 billion being collected last year. But because the Fed has kept rates low for so long, the yields that Social Security is receiving on its asset reserves have been shrinking for about a decade. Lower yields mean less in interest income for the program.
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4. Income inequality is bad news
A fourth problem is growing income inequality in the United States, which actually presents as a double whammy to the Social Security program.
For one, more earned income (wages and salary, but not investment income) is escaping the payroll tax than in previous decades. In 2019, for instance, all earned income between $0.01 and $132,900 is subject to the 12.4% payroll tax. However, earned income above this cap of $132,900 is exempt. Between 1983 and 2016, the amount of earned income exempted from the payroll tax rose from a little over $300 billion to about $1.2 trillion. This $1.2 trillion equates to nearly $150 billion in payroll tax "escaping" the program.
The other component here is that well-to-do workers are living longer and collecting a larger monthly payout. Wealthier individuals and families don't have the same financial constraints when it comes to receiving preventative care, medical care, or prescription medicines, which has led to a notable longevity difference between low- and high-income persons. As a result, they're benefiting more from Social Security than the low-income retired workers who the program was designed to protect.
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5. Congress is doing nothing
Lastly, you can blame Social Security's imminent cash woes on Congress, which has done nothing to ease the program's burden, despite being fully aware of an eventual funding shortfall for the past 34 years.
The biggest issue for lawmakers in Washington is not a lack of solutions. Rather, it's the fact that neither Democrats nor Republicans will cede an inch to find common ground between their core ideas.
Democrats would prefer to "fix" Social Security by raising additional revenue through taxation. More specifically, Democrats would minimize or close the loophole that allows the well-to-do to escape the payroll tax by increasing or eliminating the payroll tax cap.
Comparatively, Republicans would prefer to tackle the aforementioned longevity problem by gradually raising the full retirement age from 67 to as high as 70. In doing so, future generations of retirees would need to wait longer to receive their full payout or have to accept a steeper reduction to their monthly payout if claiming early. Either way, it would reduce program outlays over the long run.
Without either party willing to find common ground, no legislation to resolve Social Security's imminent cash shortfall is close to being passed. And the longer Congress waits to fix Social Security, the more burdensome an eventual fix will likely be on the working class.
