For most Americans, Social Security benefits provide a much-needed financial foundation during retirement. More than two decades of surveys from national pollster Gallup show that anywhere from 80% to 90% of current retirees rely on their monthly Social Security check to cover some portion of their expenses.
Maintaining the health of America's top retirement program is paramount to the financial well-being of our nation's seniors. However, nearly four decades of annually released reports from the Social Security Board of Trustees shows that the program's foundation has begun to crack in a big way.
President Joe Biden believes he has a fix for what ails Social Security, but a deeper dive into his proposals yields some unexpected consequences for the U.S. economy.
Joe Biden listening to former President Barack Obama. Image source: Official White House Photo by Pete Souza.
Joe Biden wants to make four big changes to Social Security
Since 1985, the annually published Trustees Report has cautioned that Social Security is facing a long-term funding-obligation shortfall. In other words, the program's projected revenue collection in the 75 years following the release of the report isn't expected to cover forecast outlays (i.e., benefits and administrative expenses). In 2023, this long-term cash shortfall stood at a jaw-dropping $22.4 trillion, and it continues to grow.
This long-term funding-obligation shortfall is the result of multiple demographic shifts, including a more-than halving in legal immigration into the U.S. over the past 25 years, historically low U.S. birth rates, and rising income inequality.
With Social Security already spending more than it's bringing in, the latest Trustees Report opines that the Old-Age and Survivors Insurance Trust Fund (OASI), which is responsible for parsing out payments to nearly 50 million retired workers each month, could exhaust its asset reserves (i.e., excess cash built up since inception) by 2033. Depleting the OASI's asset reserves may result in the need for sweeping benefit cuts of up to 23% a decade from now.
President Biden has made clear he doesn't want to see that happen. Prior to being elected president in November 2020, then-candidate Biden released a sweeping proposal that called for four major changes to Social Security:
- Reinstate the payroll tax on earned income above $400,000: In 2023, all earned income (wages and salary but not investment income) between $0.01 and $160,200 is subject to the 12.4% payroll tax, which is the primary funding mechanism for Social Security. Earned income above $160,200 is currently exempt from the payroll tax. Under Biden's proposal, the payroll tax would be reinstated on earned income above $400,000, and a doughnut hole would be created between the maximum taxable earnings cap (the $160,200 figure) and $400,000 where earned income would remain exempt.
- Switch the inflationary tether from the CPI-W to the CPI-E: Since 1975, the Consumer Price Index for Urban Wages Earners and Clerical Workers (CPI-W) has been Social Security's measure of inflation and cost-of-living adjustment (COLA) determinant. Unfortunately, it's been doing a poor job and costing seniors their purchasing power. Biden has proposed swapping it out for the Consumer Price Index for the Elderly (CPI-E), which focuses on senior household spending and would, presumably, result in higher annual COLAs.
- Increase the special minimum benefit: For lifetime low-earning workers with at least 30 years of coverage, the maximum benefit in 2023 is a mere $1,033.50 per month. That's well below the federal poverty rate for a single individual of $1,215 per month. President Biden proposes raising the special minimum benefit to 125% of the federal poverty level.
- Beef up the primary insurance amount for aged beneficiaries: Lastly, Joe Biden has suggested gradually increasing the primary insurance amount (PIA) by 1% annually, beginning at age 78 and continuing through age 82. This cumulative 5% boost to the PIA for aged beneficiaries is designed to offset certain costs that can increase later in life, such as prescription-drug or medical-transportation expenses.
Image source: Getty Images.
Joe Biden's Social Security plan has some unintended consequences for the U.S. economy
A number of statistical analyses were conducted on Joe Biden's policy proposals during his 2020 presidential campaign. Among them is the Penn Wharton Budget Model (PWBM), a non-partisan, research-driven initiative that examines the fiscal impacts of policy proposals.
In March 2020, just shy of eight months prior to Election Day, PWBM released its detailed analysis of the Social Security changes Joe Biden called for. Whereas the long-range (2020 to 2094) actuarial deficit was calculated at 3.55% of taxable payroll for the Old-Age, Survivors, and Disability Insurance Trust Funds (OASDI) under the current law, Biden's proposal would reduce this long-term actuarial deficit for the OASDI to 2.01% of taxable payroll. In plain English, it reduces the magnitude of Social Security's expected 75-year funding shortfall.
However, Joe Biden's proposed Social Security changes would also be expected to have unintended consequences for the U.S. economy. According to the economists behind PWBM, two factors would be responsible for reducing U.S. gross domestic product (GDP) by 0.6% in 2030 and 0.8% by 2050.
The first problem noted by PWBM is that Biden's Social Security overhaul provides a boost to all beneficiaries. Though the focus on lifting the special minimum benefit and gradually increasing the PIA would predominantly help individuals with little or no retirement savings, switching to the CPI-E from the CPI-W increases benefits for everyone. This cumulative increase in expected Social Security benefits over time would result in fewer work hours or earlier retirement, especially for households with ample retirement savings. Fewer work hours and/or early retirement would negatively impact the country's productivity.
The second issue pointed out by PWBM economists with Biden's Social Security plan is that it would "distort labor supply decisions by more than the current payroll tax."
As things stand right now, the more a worker earns on an inflation-adjusted basis over their 35 highest-earning years, up to the maximum taxable earnings cap, the higher their Social Security benefit will be at full retirement age. Though workers don't get back from Social Security the same dollar they paid in via the payroll tax, PWBM notes there is something of a "contribution-benefit" linkage that exists.
Meanwhile, the creation of a doughnut hole and the reinstatement of the payroll tax on high-earning workers doesn't add any additional benefits. Without any added benefits, these high-earning workers would be expected to potentially work less, defer their income, or perhaps derive their income from small businesses where their earnings could be untouched by the payroll tax. That's also a net-negative for the U.S. economy.
Economic consequences aside, this is the biggest problem with Biden's Social Security proposal
Any proposal on Capitol Hill, be it for Social Security or not, is going to have a tough hill to climb if well-respected economists are forecasting a long-term decline in U.S. GDP as a result. But when push comes to shove, the economic consequences of Biden's Social Security plan are a distant second to another problem. Namely, it doesn't resolve the program's long-term funding-obligation shortfall.
A separate analysis conducted by Washington, D.C.-based think tank Urban Institute in October 2020 found that Biden's Social Security overhaul would only extend the solvency of the program's asset reserves by roughly five years. If we assume the same analysis holds true in 2023, the OASI would be exhausted by 2038 instead of 2033. Note: Social Security is in no danger of going bankrupt or becoming insolvent. But the "solvency" of its asset reserves is very much in question.
Although increasing taxation on the well-to-do would provide an immediate and sizable increase in annual revenue for Social Security, the other tenets of Biden's proposal redirect this capital to boost the special minimum benefit, increase PIAs, and lift annual COLAs for all beneficiaries. In short, much of the revenue boost Social Security would receive from taxing the rich would be offset by benefit increases elsewhere. Very little progress would be made in reducing the program's long-term funding-obligation shortfall.
Multiple analyses have shown that simply taxing the rich or removing the maximum taxable earnings cap altogether simply isn't enough to cover Social Security's long-term cash shortfall. To truly fix Social Security, lawmakers will have to consider additional solutions, which may include raising the payroll tax above 12.4%, gradually increasing the full retirement age, or perhaps means-testing for benefits.
