For over 80 years, Social Security has been a financial rock for our nation’s retired workforce. More than 46 million of today’s program beneficiaries are retired workers, with approximately a third of these recipients pulled out of poverty each year as a direct result of their payout.
However, it’s also a program in serious flux. Even though Social Security is at no risk of going bankrupt — this is because two of the program’s three sources of revenue are recurring — the annually released report from the Social Security Board of Trustees has highlighted an expected long-term (75-year) cash shortfall every year since 1985.
The Social Security Board of Trustees offers a grim outlook
In the latest report, the Board of Trustees cautioned that Social Security’s outlays would outpace revenue collected by an unsightly $16.8 trillion between 2035 and 2094, with 2035 representing the year where the program’s $2.9 trillion in asset reserves are estimated to be completely exhausted.
How, exactly, does the most important social program in the country find itself on such shaky ground? The answer predominantly lies with a number of ongoing demographic changes.
Most folks are probably familiar with the idea of baby boomers retiring and weighing down the worker-to-beneficiary ratio.
You may also be aware that rising life expectancy has vastly outpaced the increase in Social Security’s full retirement age, which is allowing beneficiaries to receive a payout for a longer period of time. But there are other major factors at work here, including:
- Rising income inequality
- Record-low birth rates
- A near-halving in net legal immigration rates over the past two decades
- Historically low yields on special-issue bonds held by the Social Security program
But even this dire projection of the program’s cash shortfall over the next 75 years may prove to be optimistic.
Forget a $16.8 trillion cash shortfall. Try $53 trillion!
Although the primary focus of the Trustees’ 276-page annual report is to decipher how monetary, fiscal, and demographic changes could alter the short-term (10-year) and long-term (75-year) outlook for Social Security, the Board also includes what’s known as an infinite horizon projection.
As the name implies, an infinite horizon projection looks well beyond the 75-year mark to estimate the program’s unfunded obligations. Take note that the longer the Trustees look out beyond the 75-year mark, the greater the uncertainty and the higher the chance of variability with the estimate.
With that being said, the 2020 report points to — drum roll — $53 trillion in unfunded obligations in the infinite horizon model. For some context here, that’s up from $32.1 trillion in 2016, $16.1 trillion in the 2010 report, and is approximately three times higher than the estimated long-term capital shortfall of $16.8 trillion that’s been widely touted. This $53 trillion shortfall will equate to an across-the-board reduction in benefits of up to 27% if not dealt with.
Why has the program’s forecast infinite horizon cash shortfall risen by nearly $37 trillion in 12 years? One factor cited by the report was the persistent decline in fertility rates. Social Security relies on the steady replacement of workers to offset those who choose to retire, which means steady or rising birth rates are needed. For the past decade, birth rates have been precipitously declining and show little sign of a rebound.
The Trustees also point to a reduction in the real interest rate from 2.5% to 2.3%, as well as the repeal of the Affordable Care Act’s excise tax on employer-sponsored group health insurance premiums, as reasons behind the rapid increase in infinite horizon unfunded obligations. Both of these factors discourage wage growth, and therefore limit future payroll tax collection.
A bipartisan fix will be needed
The big question is: How do we fix Social Security? According to the Trustees report, “Making Social Security solvent over the infinite horizon requires some combination of increased revenue or reduced benefits for current and future participants amounting to $53 trillion in present value.”
Based on estimates provided by the Board, a payroll tax increase of 4.6 percentage points would resolve this infinite shortfall. In other words, increasing the current payroll tax collection from 12.4% of earned income (up to the maximum taxable earnings cap) to 17% would cover the program’s projected infinite horizon unfunded obligations. For the typical worker who splits their payroll tax liability with their employer, it would mean a tax liability of 8.5% on their earned income, rather than the 6.2% they pay today.
More than likely, however, lawmakers are going to be unable to push through such a large payroll tax increase on working Americans. While polling has shown that workers favor higher tax rates if it means saving Social Security, the magnitude of the tax hike they’re willing to accept is rather small. A “Voice of the People” survey conducted in 2016 found that favorability ended with a personal liability of 6.6%, or 40 basis points higher than it is now. A 7.2% personal liability rate (i.e., a 14.4% overall payroll tax on earned income for employees) had just 19% support among those polled.
In order to provide a lasting fix for Social Security, we’re going to need a bipartisan bill that leans on the core proposal of each party. This means accepting the Democrats’ idea of increasing taxation on the well-to-do to tackle the program’s most immediate cash concerns. It also means counting on the Republicans’ proposal to gradually raise the full retirement age to as high as 70. Only a bipartisan solution can tackle Social Security’s near-term and long-term concerns.
Unfortunately, the longer lawmakers wait to act, the larger this funding obligation shortfall is liable to grow.
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Source: The Motley Fool