In just 12 days, on Jan. 1, Social Security will be celebrating the 80th anniversary of its first retired-worker payouts. After being signed into law all the way back in August 1935, Social Security has easily become the most successful social program in existence. Today, the program is responsible for making monthly payouts to 64 million Americans, more than 22 million of whom rely on their guaranteed benefits to pull themselves out of poverty.
However, America's most important social program isn't on the best financial footing, and that may all come to a head in the upcoming decade.
The 2020s could be terrible for Social Security
As some of you may be aware, the Social Security Board of Trustees provides a report each year that examines the long-term (75-year) and short-term (10-year) outlook for the program, as well as dives into the previous year's financials and other demographic trends. Since 1985, the Trustees report has warned that revenue collection would be insufficient to cover program outlays over the long term. In other words, Congress has known for more than 30 years that Social Security was in trouble and has pretty much done nothing about it.
According to the 2019 Trustees report, the program's nearly $2.9 trillion in asset reserves is expected to be completely exhausted by 2035. Furthermore, there will be a funding gap of an estimated $13.9 trillion between 2035 and 2093, utilizing the existing payout schedule. In plain English, Social Security isn't going bankrupt, but the current payout schedule simply isn't sustainable over a long period, due to a number of ongoing demographic changes. What this means is that retired workers and future retirees could be facing an up to 23% reduction to their monthly payouts by as soon as 2035.
This isn't a rosy outlook, especially with 62% of seniors relying on Social Security for half of their monthly income. But there's a real possibility this outlook could grow even darker over the next decade.
The rich keep getting richer, and that's a problem
For starters, it's become more and more challenging for Social Security's revenue-collecting workhorse, the 12.4% payroll tax on earned income (wages and salary), to make ends meet for the program. That's because the rich keep getting richer, and more income continues to be exempted from the payroll tax. Between 1983 and 2016, the amount of earned income exempted rose from north of $300 billion to $1.2 trillion.
How's this possible? The payroll tax has a cap, which in 2020 is $137,700. This means the roughly 94% of workers who'll earn less than $137,700 in 2020 will pay into Social Security on every dollar they earn. Meanwhile, the approximately 6% of workers earning above $137,700 will have those dollars above $137,700 exempted from the payroll tax. This exemption exists because there's also a cap on how much the program will pay out at full retirement age.
You'll also note that only earned income is subjected to the payroll tax. This means pretty much all forms of investment income receive a free pass from payroll taxation. As the rich get richer, more income escapes the grasp of Social Security's key revenue generator.
Birth rates are in a precipitous decline
Another problem that could really start catching up with Social Security is the persistent drop in U.S. birth rates, which really became noticeable over the past decade. In fact, the fertility rate in the U.S. among women of childbearing age fell to an all-time low in 2018.
Why the big drop in births? It's a confluence of factors that include:
- The perception of weakness in the U.S. economy.
- Easier access to contraceptive devices and birth control medication.
- A decline in unplanned pregnancies.
- A purposeful decision by millennials to hold off on getting married and starting a family.
For Social Security, any prolonged period of low birth rates could prove very costly. That's because Social Security counts on a growing population of new workers to help support those who are retired or disabled and receiving a benefit. If the future worker pool turns out to be substantially lower than models suggest, the aforementioned long-term funding gap for Social Security could be much larger than expected.
Net immigration continues to slow
It's an often-overlooked issue, but declining net immigration presents a real problem for Social Security.
Whether you realize it or not, Social Security relies on a steady flow of legal immigrants into the country in order to be successful. Most legal immigrants tend be to younger, which means they'll enter the workforce for decades to come. And assuming they become citizens, they'll earn a retired worker benefit for themselves many years down the line. The key here is legal immigrants are counted on to boost payroll-tax collection.
However, an examination of U.S. net migration trends (legal immigrants who entered the country minus those folks who emigrated elsewhere) shows something disturbing. According to data available from the St. Louis Federal Reserve, U.S. net immigration on a rolling five-year basis has been nearly halved over the past 20 years.
The Trustees report is very clear in its modeling that more net immigration will lead to a stronger Social Security program. Yet we appear to be headed in the opposite direction at the moment.
Congress continues to twiddle its thumbs
Perhaps the icing on the cake is that, despite more than three decades of warnings, political hubris has kept lawmakers on Capitol Hill from making any progress on fixing Social Security.
Solutions definitely aren't the problem. Both Democrats and Republicans have viable solutions that would strengthen the Social Security program. Democrats want to raise revenue by increasing or removing the payroll tax cap, whereas Republicans want the full retirement age gradually raised to reduce long-term program outlays. Both solutions work. Unfortunately, since neither party will concede an inch to their opposition on a middle-ground fix, nothing is getting done.
Here's the real kicker: The longer Congress waits to enact a fix, the costlier it's going to be on working Americans, who are the ones predominantly footing the bill to keep Social Security solvent. In other words, the long-term funding gap grows every year in which lawmakers fail to act. Thus, if and when Congress finally acts, working Americans could be in a world of hurt.
There's no denying that Social Security is the most storied social program in history. But the 2020s could prove to be a very challenging decade that sees the program's outlook worsen. I hope I'm wrong, but only time will tell.