For more than three months, the coronavirus disease 2019 (COVID-19) pandemic has upended society as we know it. The U.S. becoming the epicenter of the pandemic left regulators with little choice but to shut down nonessential businesses throughout most of the country to save lives.
But it's not just the physical well-being of Americans that's been threatened by COVID-19. This illness is a direct threat to people's financial footing, too. We've seen more than 41 million people file for initial unemployment benefits in a 10-week stretch, and the Congressional Budget Office has forecast a federal deficit for fiscal 2020 (ended Sept. 30, 2020) of $3.7 trillion!
It's also going to have a direct impact on the most-successful social program in the country, which currently provides benefits to more than 64 million Americans: Social Security. Here are 10 ways COVID-19 is directly or indirectly expected to affect the nearly 85-year-old Social Security program.
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1. A notable reduction to payroll tax collection
The most direct adverse impact, at least in the short run, is going to come from the tens of millions of people who've been laid off.
You see, Social Security has three primary sources of funding, of which the 12.4% payroll tax on earned income (i.e., wages and salaries) tops the list. In 2019, it was responsible for almost 89% of the $1.06 trillion the program collected. The problem is that if people are out of work, Social Security is going to generate less in the way of payroll tax revenue. Unemployment benefits, which were being paid out to approximately 21 million people as of last week, are exempt from Social Security's payroll tax.
2. Less net interest income generated from the program's asset reserves
The Federal Reserve's response to the coronavirus pandemic will also dent Social Security's ability to generate interest income. With the nation's central bank lowering the federal funds target back to an all-time low of 0% to 0.25%, Social Security's $2.9 trillion in asset reserves, which are required by law to be invested in special-issue bonds and certificates of indebtedness, will bring in less interest income for newly issued bonds for the foreseeable future.
3. A decline in taxation-of-benefits revenue
Social Security's third source of income, the taxation of benefits, is also likely to be adversely impacted. With COVID-19 leading to layoffs, furloughs, or reduced income, the thresholds that qualify a Social Security recipient or married couple for taxation are less likely to be hit. As a reminder, the federal taxation of benefits kicks in at $25,000 for a single taxpayer and $32,000 for couples filing jointly.
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4. A reduced COLA, or perhaps no COLA at all
The virtual shutdown of nonessential businesses across most of the country is liable to send the U.S. economy into its first recession in 11 years. In the process, we're seeing the demand for goods and services fall, which is, in turn, negatively weighing on the price of many of these goods and services.
I've previously explained in detail how the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) is used to calculate Social Security's annual cost-of-living adjustment (COLA). The decline in prices for categories like energy, transportation, and autos is likely to lead to a smaller COLA or no COLA at all in 2021.
5. Lower initial benefits
On a longer-term basis, the initial benefits received by retired workers once they do claim their payout will likely be lower because of the coronavirus. Being out of work or dealing with reduced earning capacity could adversely impact what workers receive when they retire.
Admittedly, this impact could be relatively small if the recovery from COVID-19 is swift and if workers choose to work well past the 35 years that are taken into account by the Social Security Administration when calculating an individual's retirement benefit. But make no mistake about it: The impact on initial payouts isn't positive.
6. Low inflation reduces wage and COLA growth over the long run
To make matters worse, a recent analysis from Penn Wharton Budget Model (PWBM) projects that the low-inflation environment we're in now is going to suppress wage growth. If workers across most sectors and industries see their wage or salary growth slow, it means less in the way of payroll tax collected by the Social Security program.
Additionally, a low-inflation environment will probably work against existing beneficiaries by weighing down future COLAs.
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7. A higher mortality rate
As the PWBM model also points out, a higher mortality rate among elderly Americans due to COVID-19 is estimated to lead to a small long-term reduction in payment outlays. Over the next 75 years, the PWBM's projected actuarial balance improves by 1 basis point to negative 3.07% from negative 3.08%.
However, the PWBM model is very clear that the decline in interest rates, which adversely impacts interest income and weighs down inflation rates, is responsible for the lion's share of Social Security's worsening actuarial balance in the wake of COVID-19.
8. Reduced net legal immigration
The coronavirus pandemic has also required many countries, including the U.S., to temporarily close their borders as well as to reassess their legal immigration policies.
The Social Security program is dependent on a steady level of legal immigration into the U.S. given that these migrants tend to be younger and spend decades in the labor force generating payroll tax revenue. Based on projections from the 2020 Social Security Board of Trustees report, an average of 1.261 million net legal immigrants is needed annually over the next 75 years to simply maintain the current trajectory, which has Social Security staring down $16.8 trillion in unfunded obligations. But if an average of 946,000 net legal immigrants enters the U.S. annually over the long run (which happens to be almost exactly what we've been averaging in recent years), the cost to fix Social Security goes up by almost $1.8 trillion.
9. Record-low birth rates persist
While some folks might think that stay-at-home orders associated with COVID-19 could lead to a second baby boom, that's probably not going to be the case. In fact, the economic hardships associated with the coronavirus, such as high unemployment and a weak economy, could exacerbate already record-low birth rates.
The concern for Social Security is that consistently low birth rates are almost certain to weigh down the worker-to-beneficiary ratio. If birth rates remain where they are now over the long run, the program's unfunded obligations could increase by roughly $3 trillion.
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10. The Trust Fund depletion date moves forward
Finally, the PWBM projects that Social Security's asset reserve depletion date has been moved forward by between two and four years as a result of the COVID-19 pandemic. According to the analysis, Social Security's estimated exhaustion of its $2.9 trillion in asset reserves will now happen in 2032 in a U-shaped recovery or 2034 in a V-shaped recovery. For context, it was estimated to happen in 2036 by PWBM prior to the pandemic.
There's little question that COVID-19 is going to have a long-lasting impact on our nation's most-important social program.
