According to the Social Security Board of Trustees, America's most important social program is nearly at an inflection point -- and it's not one that folks have been looking forward to.
Based on short- and long-term estimates found in the latest Trustees report, Social Security, a program that's currently providing a payout to more than 64 million people a month, is very close to expending more than it's generating in revenue.
Social Security is nearing a feared inflection point
In the 2018 report from the Trustees, it was forecast that Social Security would see its first net-cash outflow since 1982. This wound up being proved incorrect, with the passage of the Tax Cuts and Jobs Act providing enough of an economic lift to lead the program to a $3 billion net-cash surplus in 2018. Though this is the smallest net-cash surplus since the program's last net-cash outflow, it nevertheless proved forecasters wrong, at least for another year.
But times are changing quickly for Social Security.
As I recently pointed out, published investment-holdings data from the Social Security Administration shows that the program's asset reserves have declined by $26 billion since the beginning of the year, through November. Social Security's "asset reserves" is a fancy way of describing its cumulative net-cash surpluses since inception that have, by law, been invested into special-issue bonds and certificates of indebtedness. Both of these assets pay interest to the program, which accounted for over 8% of the $1 trillion collected in 2018.
A number of ongoing demographic changes -- such as increased longevity, the retirement of boomers, growing income inequality, declining net immigration, and lower birth rates -- are all taking their toll on the program. Whether in 2019 or perhaps 2020, the likelihood appears very high that Social Security's nearly $2.9 trillion in asset reserves will shrink for the first time in close to four decades.
Unfortunately, this won't be a one-off event or something that'll simply remedy itself. As more boomers leave the workforce and these other demographic factors take shape, the annual net-cash outflow from Social Security will rise dramatically in the years to come. The intermediate-cost model suggests that by 2035, a mere 15 years from now, persistent outflows will have completely exhausted Social Security's asset reserves.
The question is: What happens then?
Social Security can't go bankrupt, even if its asset reserves run dry
On the bright side, the answer isn't the bankruptcy or insolvency of the Social Security program, so breathe a sigh of relief. Believe it or not, the way Social Security is currently funded ensures that the program can never go bankrupt.
You see, Social Security has three sources of funding:
- A 12.4% payroll on earned income (ranging up to $132,900 in 2019).
- The taxation of Social Security benefits for beneficiaries earning more than select income thresholds.
- The interest income earned on the program's asset reserves.
If Social Security's asset reserves were to be completely depleted, there would no longer be any interest income generated on an annual basis. For context, $83 billion was generated from interest income in 2018.
Thankfully, the payroll tax on earned income and the taxation of benefits are recurring sources of income. Barring a change to how the program is funded at the congressional level, Social Security would continue to receive plenty of income from taxing working Americans and middle- to upper-income beneficiaries. Put plainly, there will always be money rolling into Social Security that can be disbursed to eligible beneficiaries, regardless of whether there's money in the program's asset reserves or not.
No asset reserves means an across-the-board cut to benefits
Of course, there's a downside, too.
Declining asset reserves are a plain-as-day indication that the existing payout schedule, inclusive of cost-of-living adjustments, isn't sustainable over the long run. It means that lawmakers will have to decide to either raise additional revenue to cover the forecast cash shortfall, or reduce expenditures, or enact some combination of the two.
But what if lawmakers continue their stalemate and do nothing, leading to the eventual exhaustion of Social Security's asset reserves? What then?
Unfortunately, the next step would be an across-the-board reduction in benefits for then-current and all future beneficiaries. The latest Trustees report projected that the average reduction in monthly benefits for retired workers would be 23% if the program's asset reserves are depleted and no resolution is reached by Congress in advance of this exhaustion. That's not good news, especially with 62% of retired workers leaning on Social Security for at least half of their income.
If there is a positive to pull out of this situation, it's that lawmakers have always come to Social Security's rescue with a bipartisan solution in the past. The thing is, Congress tends to wait until the last minute to actually address the problem, which should, in turn, result in working Americans paying the price in the form of higher payroll tax liability.
Right now, Social Security's asset reserves simply buy the program time so lawmakers can work out a fix to the estimated $13.9 trillion cash shortfall between 2035 and 2093.