For the nearly 165 million people in today's U.S. labor force, Social Security will almost certainly play a key role during their retirement.
Over the past 20 years, national pollster Gallup has surveyed retirees to determine how many are reliant on their Social Security income to make ends meet. With the exception of the very first year of the survey, between 84% and 90% of retirees have consistently responded that Social Security accounts for a "major" or "minor" part of their needed income. In other words, very few seniors would be OK financially without a little help from America's top retirement program.
The only problem is that Social Security benefits are being cut before your eyes, whether you realize it or not.
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Social Security is in a $20 trillion hole that keeps getting deeper
Since Social Security began regular retired worker payouts in 1940, the Social Security Board of Trustees has released a thorough annual report detailing the program's outlook over what it defines as the short term (10 years) and long term (75 years). The Trustees take economic changes, demographic shifts, and even fiscal policy into account when updating the outlook for Social Security.
For the past 38 years, the Trustees Report has warned that long-term revenue wouldn't cover the existing payout schedule, including annual cost-of-living adjustments (COLAs). The amount of the expected long-term cash shortfall has grown steadily.
As of the 2022 Board of Trustees Report, Social Security was facing an estimated cash shortfall of $20.4 trillion through 2096. Based on the most likely forecast put forth by the Trustees, the Old-Age and Survivors Trust (OASI) -- the Trust responsible for paying more than 48 million retired workers their benefits each month -- may need to slash benefits by 23% in 2034 in order to maintain payouts through 2096 without any further cuts.
Retirees could be just 12 years away from a sizable Social Security benefit cut unless lawmakers in Congress get their act together.
Unfortunately, due to the design of Social Security and its needed revenue streams, we're already dealing with two types of benefit cuts.
Social Security's cost-of-living adjustment (COLA) misses the mark
To begin with, Social Security's measure of inflation, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), isn't doing its job as intended.
In an ideal world, when the prices of goods and services that seniors buy move higher, their monthly benefit would climb by a commensurate amount so they don't lose any purchasing power. But this has been far from the case in the real world.
As the CPI-W's full name implies, it's an index that tracks the spending habits of "urban wage earners and clerical workers." These folks typically aren't seniors and/or don't receive a Social Security benefit. More importantly, they spend their money differently than seniors. This results in the CPI-W allotting higher weightings to spending categories that don't matter as much to seniors (like education and apparel), while assigning lower weightings to crucial spending categories for seniors (like shelter and medical care). Ultimately, Social Security COLAs are missing the mark.
Based on a report issued in May by nonpartisan senior advocacy group The Senior Citizens League, the purchasing power of Social Security income has plummeted by 40% since 2000. What $100 in Social Security benefits could buy in 2000 can now only purchase $60 worth of those same goods and services.
As long as the CPI-W remains as Social Security's inflationary tether, this loss of purchasing power is likely to persist and shortchange retirees.
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The taxation of benefits is a necessary evil that's reducing take-home benefits for millions
However, a poorly designed cost-of-living adjustment isn't the only way seniors are getting the short end of the stick from Social Security. The taxation of benefits is also reducing what a substantial number of retired workers get to keep.
In 1983, with Social Security's asset reserves running on fumes, Democrats and Republicans came together and passed the last sweeping overhaul of the program. The Social Security Amendments of 1983 contained core proposals from both parties, including a gradual lift to the payroll tax rate, an increase to the full retirement age that would take place over nearly four decades, and the creation of the taxation of benefits to raise additional revenue.
When implemented in 1984, up to half of a recipient's Social Security benefits would be taxable if their modified adjusted gross income (MAGI) plus one-half of benefits surpassed $25,000 ($32,000 for a couple filing jointly). In 1993, the Clinton administration introduced a second tier of taxation that allowed up to 85% of benefits to be taxed at the federal rate if the same MAGI plus one-half of benefits formula surpassed $34,000 for a single filer or $44,000 for couples filing jointly.
Here's the kicker: The income thresholds associated with the taxation of benefits have never been adjusted for inflation. As COLAs have pushed monthly payouts higher over time, more and more retirees are becoming subjected to the taxation of benefits.
Although seniors overwhelmingly dislike the taxation of benefits, the revenue generated from taxing Social Security income is necessary to avoid further increasing the program's already jaw-dropping $20.4 trillion deficit. In other words, it's not going away anytime soon.
