For most retirees, Social Security represents an indispensable financial lifeline that helps make ends meet. For a significant percentage of the current labor force, this statement will also hold true once they retire.

But when examined as a whole, Social Security can be a complex, confusing, and potentially intimidating program for the American public to try to understand. I can change that.

Today we're going to break down three complex topics that'll be explained in plain English:

  • How America's top retirement program got itself into financial trouble.
  • The Social Security changes Democrats and Republicans want to make to strengthen the program.
  • Why a resolution to Social Security's problems is a ways off.
A person holding a Social Security card between their thumb and index finger.

Image source: Getty Images.

Social Security is facing a $20.4 trillion cash shortfall

Since 1940, Social Security has been providing eligible workers with a monthly retirement benefit. For the vast majority of those years, the program has brought in more revenue than it's paid out in benefits.

Where does Social Security get its revenue, you ask? Approximately 90% of the money it brings in comes from the 12.4% payroll tax on wages and salaries. This payroll tax is paid on earned income between $0.01 and $147,000 in 2022, although the upper limit will rise to $160,200 next year.

The remaining 10% of annual revenue comes from a combination of taxing Social Security benefits for recipients who earn above select income thresholds and the interest earned on bonds held by Social Security's trusts. The excess revenue Social Security brings in most years over what it pays out in benefits is required by law to be invested in low-risk special-issue government bonds that pay interest.

The problem for Social Security is that numerous demographic shifts are increasing payouts at a much faster pace than revenue growth. As a result, Social Security ran a deficit in 2021. This deficit is expected to grow in size every year moving forward.

These demographic shifts include the ongoing retirement of baby boomers, a slowdown in legal net immigration into the U.S., historically low birth rates, lower interest rates (which reduce the interest earned on the bonds the Social Security holds), and growing income inequality.

According to the 2022 Social Security Board of Trustees Report, the program is staring down a $20.4 trillion cash shortfall between 2022 and 2096. Although this is just an estimate, the Trustees take into account all of the demographic variables described above, as well as cost-of-living adjustments (COLA) passed along to beneficiaries most years, so their payouts keep up with the rising price of goods and services (aka inflation).

If nothing is done by lawmakers in Washington D.C. to strengthen Social Security, the Trustees believe a 23% across-the-board cut to benefits may be necessary by 2034 for the Old-Age and Survivors Insurance Trust (OASI) to sustain payouts without any further cuts until 2096. The OASI is what pays benefits to over 48 million retired workers and roughly 5.8 million survivors of deceased workers.

How Democrats and Republicans want to strengthen Social Security

Now that you have a better understanding of why Social Security is in big financial trouble, let's take a look at how lawmakers propose fixing the program.

The Democrats' proposal

There are only two ways to approach a $20.4 trillion estimated cash shortfall: raise additional revenue or cut costs. Democrats prefer the former.

The core proposal by Democrats in Congress is to increase payroll taxation on high-earning workers. As noted, wages and salaries above $147,000 in 2022 are exempt from the payroll tax.

Prior to his November 2020 election to the Oval Office, Joe Biden proposed a plan that would reinstitute the 12.4% payroll tax on earned income above $400,000. Meanwhile, earnings between $147,000 and $400,000 would remain exempt from the payroll tax. To offer some context, well in excess of $1 trillion in earned income escapes Social Security's payroll tax every year.

The other Social Security proposal offered by Democrats is to change how annual cost-of-living adjustments are calculated.

Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has been used to determine annual inflation and assign COLAs. Democrats prefer the Consumer Price Index for the Elderly (CPI-E). Whereas the CPI-W tracks the spending habits of working-age Americans who aren't usually receiving a Social Security benefit, the CPI-E would specifically track the spending habits of seniors, who make up the bulk of program recipients. The end goal here is to increase annual COLAs by using an index more reflective of the inflation seniors are contending with.

The Republicans' proposal

On the other side of the political aisle are Republican lawmakers, who collectively believe that reducing long-term program outlays will strengthen Social Security.

The key change Republicans would like to see implemented is a gradual increase to the full retirement age (FRA). A person's FRA is the age when they become eligible to receive 100% of their retired-worker benefit from Social Security. For anyone born in 1960 or later, their FRA is age 67.

Taking your benefit prior to reaching FRA means accepting a permanent lifetime reduction (i.e., not receiving 100% of what you'd be due at FRA) to your monthly payout. Meanwhile, waiting until after FRA can boost your monthly payout by up to 24% to 32%, depending on your birth year.

What the GOP has proposed is gradually raising the FRA to as much as 70. If the FRA were raised, workers would either need to wait longer to collect their full retirement benefit or claim early and accept a permanently reduced payout. No matter their choice, it would ultimately result in a lower lifetime benefit being paid out.

The other major change proposed by Republicans is switching away from the CPI-W to what's known as the Chained Consumer Price Index. The Chained CPI takes into account the idea of substitution -- trading down to a similar lower-cost good or service. In other words, if the price of ground beef has risen by 60% over the past year, consumers might trade down to a less-expensive protein source, such as pork or chicken. Utilizing the Chained CPI as Social Security's inflationary measure would almost certainly result in lower annual COLAs, which would work to reduce how much money the program pays out each year.

A Democrat donkey and Republican elephant squaring off atop an American flag.

Image source: Getty Images.

Here's why a Social Security "fix" hasn't happened yet (and may not for a while)

To be clear, Social Security's shortcomings have never lacked for resolutions on Capitol Hill. Nevertheless, Social Security legislation has stagnated for decades, with the last major overhaul of the program occurring under President Ronald Reagan in 1983. The reason for this ongoing stalemate is twofold.

To begin with, both the Democrat and Republican solutions work to strengthen Social Security -- which is the main problem. Lawmakers feel it's unnecessary to find common ground with their opposition if they have a solution that would make Social Security financially stronger.

However, both solutions have their shortcomings, too.

For example, the GOP proposal to raise the full retirement age would take decades to result in meaningful cost savings. With the OASI expected to exhaust its excess reserves by 2034, this does the program no good in the shorter term.

As for the Democrats' plan, raising the payroll tax by itself won't close the $20.4 trillion estimated cash shortfall through 2096. Further, it can be argued that the well-to-do are already paying their fair share into Social Security, given that they wouldn't see an extra cent in benefits despite increased taxation.

The second reason a resolution is likely many years away has to do with the makeup of Congress -- specifically the U.S. Senate. To amend Social Security, 60 "yes" votes are needed in the Senate. It's been over four decades since either party had a supermajority of 60 Senate seats. This means Democrats would need some form of Republican support, or vice versa, to pass any legislation. That's just not been possible, given how ideologically far apart the two sides are.

If there is a silver lining here, it's that lawmakers have a history of working together in the 11th hour. That's what happened in 1983, and it could very well happen again the closer Social Security's OASI gets to exhausting its asset reserves. But in the meantime, expect little progress on Social Security legislation despite clear evidence that the program is in dire need of adjustments.