Over the past two months, we've witnessed firsthand how disruptive a global pandemic can be on the U.S. economy and labor market. The proliferation of the coronavirus disease 2019 (COVID-19) has led to nonessential business shutdowns across the country, with approximately 22 million people losing their jobs over a four-week stretch. There's almost no question at this point that the unemployment rate could top 15% by the end of April after sitting at a 50-year low of 3.5% just a few months prior.
While the primary focus has obviously been on the health and well-being of Americans and the U.S. economy, the impact on our nation's most-storied social program shouldn't be overlooked.
Social Security: Are coronavirus benefit cuts coming?
Although Social Security has been paying benefits to eligible retired workers for more than 80 years and has survived its fair share of recessions, including the Great Recession, it's never quite faced a challenge like COVID-19. There's no mistaking that there are going to be negative consequences.
But the big question likely on the minds of the program's 64 million-plus beneficiaries is, will the coronavirus force Social Security to cut benefits? In the near-term, the answer to that question is a resounding no. However, the adverse economic effects of COVID-19 could expedite a move by lawmakers to potentially reduce program outlays in the future to strengthen the program.
Before I can better explain why Social Security is in no immediate danger from the coronavirus, and yet is in plenty of long-term trouble, it helps to understand how our nation's most-valued social program is funded.
Social Security has three primary funding sources:
- Payroll tax: A 12.4% payroll tax on earned income ranging between $0.01 and $137,700, as of 2020. Earned income refers to wages and salary but not investment income.
- Taxation of benefits: Social Security recipients whose modified adjusted gross income plus one-half of benefits tops $25,000 (or $32,000 for a couple filing jointly) will pay tax to the federal government on a portion of their benefits.
- Interest income: Social Security has accrued almost $2.9 trillion in net cash surpluses since the inception of the program. These surpluses are required by law to be invested in special-issue bonds and certificates of indebtedness, both of which pay interest into the program.
In 2018, the payroll tax provided $885 billion of the just over $1 trillion in revenue collected, with interest income and the taxation of benefits adding $83 billion and $35 billion, respectively.
There are two reasons Social Security benefits are in no immediate danger of being cut, no matter how bad the coronavirus gets. First, the payroll tax and the taxation of benefits are viewed as recurring sources of revenue. As long as the American public is working, the payroll tax, and to a lesser extent the taxation of benefits, will always be generating income for the program. These two recurring revenue sources accounted for 92% of the $1 trillion collected in 2018, and they collectively ensure that Social Security can't go bankrupt.
The second reason Social Security benefits aren't going to be cut in the near term is because the program had $2.89 trillion in asset reserves at the end of March 2020. Even if the program didn't generate a dime in revenue, this $2.89 trillion would likely be enough to pay full benefits until around the end of 2022. This cash is one heck of a buffer, at least for now.
Benefits may be safe in the near term, but the long term is a different story
But make no mistake about it, the coronavirus is going to put a hurting on Social Security's longer-term prospects.
Leading into 2020, the Social Security Board of Trustees was already forecasting that the program's nearly $2.9 trillion in asset reserves would be completely exhausted by 2035. This has to do with a number of ongoing demographic changes drastically increasing program outlays, with incoming revenue growing at a much slower pace.
More specifically, the Trustees report forecast that 2020 would mark the first year since 1982 that Social Security would suffer a net cash outflow (i.e., more money spent than is brought in). The Trustees pegged their guess at a $4.3 billion outflow. However, recent economic and labor market disruptions virtually ensure that the program's net cash outflow this year is going to be much, much bigger.
Think about this for a moment: The 12.4% payroll tax was responsible for 88.5% of the program's revenue in 2018. Now, imagine that 22 million people suddenly lost their jobs in a four-week span, and the unemployment benefits being collected by these folks are exempt from the payroll tax. Depending on how long it takes for the U.S. economy to really reopen for business, we could be looking at $100 billion or more in net cash outflows from the program in 2020.
Again, the program does have almost $2.9 trillion in asset reserves, so it's not like a $100 billion or even $200 billion net cash outflow threatens immediate payouts. However, it almost certainly expedites the timeline of when the program is expected to exhaust its asset reserves. With this timeline pushed forward, it may coerce lawmakers to actually do something about Social Security before really large benefit cuts are needed to sustain payout over the long term.