In case you haven't heard, there's trouble in paradise for America's most important social program. Despite being responsible for more than 64 million benefit checks each month, Social Security's long-term outlook is dicey, at best.
Every year, the Social Security Board of Trustees releases its short-term (10-year) and long-term (75-year) outlook for the program, taking into account a number of dynamic factors such as wage growth, population growth and mortality rates, and net immigration. Since 1985, the Trustees have warned that the program didn't have sufficient revenue income to meet its long-term expenditures -- and last year was no different.
Image source: Getty Images.
Surprisingly, Social Security's asset reserves grew in 2019
In the 2019 Trustees report, it was forecast that 2020 would become the first year since 1982 where Social Security would experience a net-cash outflow from its asset reserves. Or in plain English, Social Security's benefit payouts plus administrative costs would exceed the amount of money the program was bringing in from its three sources of income, leading to a reduction in its asset reserves (i.e., its net-cash surpluses built up since inception).
However, the Trustees' prognostications have been wrong before, such as the call for 2018 to have been the first year with a net-cash outflow since 1982. Trump's hallmark tax legislation, the Tax Cuts and Jobs Act, appears to have lit enough of a fire under economic growth to avoid the inevitable in 2018, with the program registering a $3 billion net-cash surplus.
Yet 2019 looked as if it would be the end of the line for Social Security's streak of net-cash surpluses. At the end of November, Social Security's asset reserves, which are primarily invested in interest-bearing special-issue bonds, as required by law, had declined by approximately $26 billion since the year began. It looked likely that the Trustees would be proved wrong two years in a row and Social Security would officially pass the point of no return. But that's, surprisingly, not the case.
Earlier this month, the Social Security Administration published data on the combined investment holdings of the Old Age and Survivors Insurance Trust and Disability Trust, as of Dec. 31, 2019. After beginning the year with $2,895,174,945,000, the combined value of the program's investment holdings managed to grow by $2.3 billion to $2,897,492,826,000, marking the smallest increase since 1982. That's slightly higher than the $1 billion in net-cash surplus the Trustees had forecast, and it staves off the inevitable for Social Security for at least one more year.
Image source: Getty Images.
Here's why 2020 is likely the point of no return for Social Security
Unfortunately, Social Security probably isn't going to be as lucky in 2020 and beyond. That's because a number of demographic changes are adversely impacting the program, and it's really just a matter of time before America's most important social program reaches its tipping point.
While a lot of folks have been quick to point the finger at baby boomers for retiring and ballooning the number of beneficiaries collecting checks from Social Security, they're far from the only reason Social Security is about to become a financial disaster. A number of other problems include:
- Increased longevity: We're living a lot longer than we were when payouts began 80 years ago, and Social Security was never designed to make continuous payouts to seniors for two or more decades.
- Growing income inequality: Not only are the well-to-do living considerably longer than the low-income workers that Social Security was designed to protect, but they're also collecting an above-average payout for this extended period of time.
- Low birth rates: We've witnessed birth rates among women of childbearing age hit an all-time low in 2018. If birth rates don't pick up, the worker-to-beneficiary ratio will be headed even lower.
- A slide in net immigration: Social Security counts on a steady stream of legal immigration into the country to be financially sound. That's because immigrants tend to be younger, and therefore spend decades contributing in the workforce via payroll taxes before they retire.
If 2020 does become the year that Social Security contends with a net-cash outflow, it would confirm the unsustainability of the existing payout schedule, inclusive of cost-of-living adjustments. To be crystal clear, this doesn't mean Social Security is going bankrupt, but it does portend that significant benefit cuts of up to 23% may await retired workers in 15 years or less in order to keep the program solvent.
Image source: Getty Images.
What needs to happen to fix Social Security?
With Social Security teetering on the point of no return, it's pretty evident that America's elected lawmakers need to step up and fix it. The problem is that both the Democrats and Republicans have a workable solution, but neither side is willing to compromise to find common ground with their opposition.
There are really only three schools of thought when approaching Social Security's estimated $13.9 trillion cash shortfall between 2035 (when the program's asset reserves are set to run out) and 2093:
- Additional revenue can be raised
- Benefits could be reduced
- Additional revenue could be raised, with benefits also being reduced
Democrats favor the first method, with their solution targeted at raising additional revenue. This would be done by raising or eliminating the payroll tax earnings cap, which stands at $137,700 in 2020. In simple terms, all wages and salary between $0.01 and $137,700 in 2020 will be hit with the payroll tax, which is the funding workhorse for Social Security. This allows a small percentage of well-to-do workers to have any earned income above $137,700 exempted from the payroll tax. Democrats would aim to halt this from happening, thereby boosting payroll tax revenue by taxing the well-to-do's previously exempted earnings.
Meanwhile, Republicans favor the second method of reducing program outlays by reducing lifetime benefits paid. The GOP proposes a gradual increase in the full retirement age -- the age at which a retired worker becomes eligible for 100% of their monthly benefit, as determined by their birth year -- that would require workers to either wait longer to collect their full benefit or accept a steeper reduction to their payout by claiming early. No matter the choice, lifetime benefits would be reduced.
The problem is, both unilateral solutions have deficiencies, and the third fix, which targets a bit of both, appears to work best. The Republicans' fix takes decades before savings are realized, meaning the immediate revenue boost from the Democrats' plan would be needed. Meanwhile, Democrats fail to take into account ongoing demographic changes, such as increased longevity and lower birth rates, which the GOP's cost-cutting measures would factor in.
A bipartisan solution is undoubtedly the way to go. The question is, how long is it going to take before lawmakers realize this, as well?
