As many of you might be well aware, our nation’s top social program, Social Security, is facing its biggest challenge since it was signed into law in 1935.
For each of the past 35 years, the Social Security Board of Trustees has released a report forecasting a funding obligation shortfall over the long term, which is defined as the 75 years following the release of a report. As of the 2020 report, the program’s long-term funding shortfall had reached a whopping $16.8 trillion.
News flash: Retirees’ Social Security benefits could be cut in 15 years
The good news, if a silver lining can be pulled from such a jaw-dropping figure, is that Social Security isn’t going to go bankrupt or become insolvent.
Two of its three sources of funding (the 12.4% payroll tax on earned income and the taxation of benefits) are recurring, which is to say that if Americans keep working, money will continue flowing into the program for disbursement to eligible beneficiaries.
Whether you’re already retired or plan to retire in 40 years, a Social Security retirement benefit will be waiting for you, as long as you’ve met the requisite number of work credits needed to receive a monthly payout.
However, the other side of this coin is that $16.8 trillion in unfunded obligations caused by a plethora of ongoing demographic changes can’t simply be swept under the rug. According to the Trustees report, Social Security’s $2.9 trillion in asset reserves — i.e., its net cash surpluses that have been built up since inception — will be completely exhausted by 2035.
Again, this doesn’t mean bankruptcy or insolvency. However, if nothing is done by lawmakers to resolve Social Security’s impending cash shortfall, then retired workers and survivors could be facing an across-the-board cut to benefits of up to 24% in 15 years or less.
Surprise! There’s a no-frills solution to resolving Social Security’s unfunded obligation shortfall
But here’s the thing most people don’t realize: The Trustees report outlines a surefire fix every single year, yet lawmakers haven’t once chosen to implement it.
In the 2020 report, the Trustees outlined an actuarial deficit over the next 75 years of 3.21%. The actuarial deficit describes the amount that payroll taxes would need to increase today in order to resolve the program’s long-term shortfall, as well as leave a full year’s worth of payouts in asset reserves come 2094 (i.e., a trust fund ratio of 100%). In other words, the Trustees have put it plain as day in their report that if the payroll tax were increased on all working Americans from a current level of 12.4% to 15.61% (12.4% plus 3.21%), Social Security benefits shouldn’t need to be reduced over the next 75 years, including taking into account annual cost-of-living adjustments.
The Trustees also provide an alternative option known as the “necessary tax rate,” which describes the increase needed to maintain solvency over the next 75 years but completely depletes the program’s asset reserves by the 75th year (i.e., a trust fund ratio of 0%). The necessary tax rate listed is 3.14%.
Now, keep in mind that not all working Americans would be on the hook for, say, a 15.61% tax rate on their earned income. While the self-employed would be, those folks employed by a company or someone else would split their payroll tax liability with their employer. This means that instead of you and your employer each paying 6.2% at the moment (thus totaling 12.4%), you’d each be responsible for 7.805%, or 15.61% total.
For the average worker bringing home $50,000 a year, we’re talking about an extra $802.50 in payroll taxes paid to completely resolve Social Security’s unfunded obligations.
A surefire fix with surefire pushback
So why haven’t lawmakers chosen to implement this solution to resolve Social Security’s long-term cash shortfall?
The answer can likely be traced to significant ideological differences between Democrats and Republicans in Congress, as well as to the possibility of public pushback.
For instance, Democrats have long favored the idea of resolving Social Security’s funding shortfall by increasing revenue collection. However, this wouldn’t be done by passing along a 3%-plus increase on payroll taxes for all working Americans. Rather, it would entail raising or eliminating the payroll tax earnings cap, which is set at $137,700 in 2020. Whereas 94% of working Americans pay into Social Security on every dollar they earn, the 6% of workers who’ll earn more than $137,700 in 2020 would have some, or perhaps most, of their income exempted from the payroll tax. Democrats want to reduce or eliminate this loophole, thereby requiring the wealthy to pay more into the system.
Meanwhile, Republicans prefer an approach that gradually increases the full retirement age, which is the age at which you become eligible for 100% of your monthly payout, as determined by your birth year. Currently set to peak at age 67 in 2022, the GOP would like to see this age increased to 70. Doing so wouldn’t affect current and near-term retirees, but it would require future generations of retired workers to either wait longer to receive their full payout or accept a steep reduction in benefits by claiming early. In essence, the Republican plan aims to cut outlays over the long run.
Since the Democrats’ and Republicans’ plans both work to strengthen Social Security, neither side feels the need to find common ground with the opposition.
The other issue here is that while working Americans are amenable to the idea of increased payroll taxes to save Social Security, favorability goes downhill very rapidly the higher the tax levels increase. The “Voice of the People” survey in 2016 asked almost 8,700 respondents if they’d be willing to shoulder a 0.4% increase in their personal liability to 6.6% from 6.2%, and 76% were in favor. But when asked if a 1% increase to 7.2% (i.e., a 14.4% total rate) would fly, just 19% supported the idea. According to the Trustees report, a 1.605% personal liability increase is needed for folks employed by a company or someone else, so you can imagine how low the support would be for such an increase.
Suffice it to say that this surefire fix isn’t off the table, but it’s not anyone’s first choice, either.
— Sean Williams
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Source: The Motley Fool