For better or worse, Social Security serves as a financial foundation for most retirees. Nearly 9 out of 10 retired workers are reliant on Social Security income, in some capacity, to cover their monthly expenses. Further, the Center on Budget and Policy Priorities finds that the program is responsible for pulling more than 21 million people out of poverty each year, including close to 15.4 million adults aged 65 and over.
Yet despite how crucial Social Security is to the financial well-being of an aging workforce, America's top retirement program is on ever-shakier footing.
Fixing Social Security is of paramount importance to current and future generations of retirees -- and this all starts with actions taken by lawmakers on Capitol Hill, as well as President Joe Biden.
Joe Biden listening to former President Barack Obama. Image source: Official White House Photo by Pete Souza.
Demographic shifts have created a greater than $22 trillion funding shortfall
To make one thing absolutely clear from the get-go, Social Security is in zero danger of becoming insolvent or going bankrupt. It generates approximately 90% of its revenue from the 12.4% payroll tax on earned income (wages and salary, but not investment income), which means that as long as Americans keep working and paying their taxes, the program will collect revenue that can be disbursed to eligible beneficiaries.
What isn't sustainable for America's top retirement program is its payment schedule, including annual cost-of-living adjustments (COLAs). Over the next 75 years, the Social Security Board Trustees estimate the program will have a $22.4 trillion funding obligation shortfall.
What's more, the Old-Age and Survivors Insurance Trust Fund (OASI), which covers monthly benefits to nearly 50 million retired workers and 5.8 million survivor beneficiaries, is expected to exhaust its asset reserves by 2033. If and when the OASI's asset reserves are exhausted, sweeping benefit cuts of up to 23% would be needed to sustain benefit checks through 2097, without the need for any additional reductions.
The "blame" for Social Security's financial woes lies with a number of ongoing demographic shifts:
- Baby boomers are leaving the workforce, leading to an increase in retired workers taking benefits and weighing down the worker-to-beneficiary ratio.
- Average life expectancy since the first retired-worker payout on Jan. 31, 1940, has increased from about 63 years to a little over 76 years. While living longer is great, it's taxing a retirement program that was never designed to pay benefits to seniors for multiple decades.
- Rising income inequality has allowed more earned income to escape taxation over the past four decades.
- Legal immigration into the U.S. has been more than halved over the past 25 years. Most immigrants coming into the U.S. are young and will spend decades in the labor force contributing to the program via the payroll tax.
- S. birth rates are near historic lows. A meaningful drop in births will further weigh on the worker-to-beneficiary ratio in the coming years.
Joe Biden has a four-point plan to change Social Security
Washington, D.C., has no shortage of proposals on how best to "fix" Social Security. One of the solutions comes from none other than President Biden. While on the campaign trail prior to his November 2020 election, then-candidate Biden released a four-point plan designed to overhaul Social Security and strengthen the program.
1. Increase payroll taxation on high earners
The flagship change proposed by Joe Biden is to increase the amount of payroll tax paid by the top 1% of earners in America.
This year, all earned income between $0.01 and $160,200 is subject to the 12.4% payroll tax. Since an estimated 94% of working Americans will earn less than $160,200 this year, they'll be paying into Social Security with every dollar they earn. Meanwhile, the 6% of high earners who'll bring home more than $160,200 (this upper bound is known as the "maximum taxable earning cap") won't owe any payroll tax above this maximum taxable earnings cap.
Biden's proposal would see the payroll tax reinstated on earned income above $400,000, which would meaningfully increase revenue for the program. Meanwhile, a doughnut hole would be created between the maximum taxable earnings cap and $400,000 where earned income would remain exempt. The catch is that the maximum taxable earnings cap increases in lockstep with the National Average Wage Index most years. In other words, this doughnut hole would close after a few decades, eventually exposing all earned income to the payroll tax.
2. Change Social Security's inflationary tether from the CPI-W to the CPI-E
Another sizable change offered by President Biden is to alter how Social Security accounts for inflation.
Since 1975, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) has measured inflation for Social Security and been responsible for determining annual COLAs. But this inflationary index is tracking the spending habits of urban wage earners and clerical workers, who are typically working-age Americans who are unlikely to be receiving a Social Security benefit. Since January 2000, the purchasing power of a Social Security dollar has plunged 36%, according to an analysis by nonpartisan senior advocacy group, The Senior Citizens League.
Meanwhile, the Consumer Price Index for the Elderly (CPI-E), as its name suggests, tracks the spending habits of households with persons aged 62 and over. Considering that 86% of Social Security's more than 66 million beneficiaries are aged 62 and above, an inflationary index that tracks the spending habits of seniors should result in more accurate (i.e., higher) cost-of-living adjustments.
3. Increase the special minimum benefit
A third change suggested by Joe Biden is to increase the special minimum benefit that's paid to lifetime low-earning workers.
For a lifetime low-earner with 30 years of coverage, the maximum monthly Social Security benefit in 2023 is $1,033.50. That's well below the federal poverty level of $1,215 per month for a single filer this year.
Biden's proposal is simple: Increase the special minimum benefit to 125% of the federal poverty level, and adjust it every year thereafter. If this proposal were law in 2023, the special minimum benefit for a lifetime low-earning worker with 30 years of coverage would be $1,518.75 per month.
4. Raise the primary insurance amount for aged beneficiaries
The fourth and final Social Security change proposed by President Biden is to gradually increase the primary insurance amount (PIA) for aged beneficiaries.
As we get older, certain expenses can mount, such as prescription drugs and medical transportation. To help offset some of these later-in-life expenses, Biden proposes a 1% gradual increase to the PIA beginning at age 78 and continuing through age 82. This cumulative 5% increase in PIA would lift monthly benefits for those who need it most.
Image source: Getty Images.
Biden's Social Security plan comes with a big cost to America
On the surface, Biden's four-point plan to change Social Security would, indeed, lift benefits. Moving to the CPI-E would increase annual COLAs over time for all recipients, while lifetime low-earners and the elderly would see an even bigger boost in what they receive.
However, the president's plan comes with a hefty cost.
In March 2020, the research-driven Penn Wharton Budget Model (PWBM) analyzed the fiscal impacts of Biden's Social Security proposals and came to the conclusion that it would, ultimately, hurt economic activity. The economists behind PWBM estimate a 0.6% decline in U.S. gross domestic product (GDP) by 2030 and an even greater 0.8% drop in U.S. GDP by 2050. With a separate report from PwC in 2017 estimating the U.S. will reach $34.1 trillion in GDP by 2050, the implication would be for a $273 billion future cost to America.
PWBM's economists note two prominent issues with Joe Biden's plan that would lead to this estimated reduction in U.S. GDP by 2050.
To begin with, switching to the CPI-E would increase COLAs across the board. Though it would offer a lift to low earners and those with little retirement savings who need it most, it would also encourage high earners and those with a lot of retirement savings to retire sooner or work fewer hours. The end result would be lower productivity for the U.S. economy.
The other problem noted by PWBM's economists is that Biden's plan would "distort labor supply decisions by more than the current payroll tax."
In plainer English, there's the perception of a contribution-benefit link when it comes to Social Security. Even though workers aren't getting back the same dollar they're contributing to the program via the payroll tax, there's the belief that if you pay more into Social Security, you'll get more out of it.
If Biden's proposal to reinstate the payroll tax at $400,000 were to become law, high earners, who'd receive no extra benefit yet would suddenly owe a lot more in taxes, would opt to work less, defer their income, or potentially generate their income from alternative sources that aren't taxable by Social Security.
Although President Biden's four-point Social Security plan would modestly extend the solvency of the program's asset reserves, it could prove costly to America.
