Social Insecurity: The Solvency of America’s Favorite Entitlement Program

McHenry Lee, JHU:

Formally known as Old Age, Survivors, and Disability Insurance program (OASDI), Social Security has been an unmitigated success for eight decades. It has lifted millions of seniors out of poverty and has provided an economic safety net for America’s retired community by creating social insurance. However, current economic and demographic trends threaten the program’s future solvency. If Washington does not engage in meaningful and lasting reform, the Social Security trust fund will run dry by 2035, causing benefits to drop at least 20% and payroll taxes to skyrocket in order to simply continue promised benefit payments.

In order to properly assess the issues facing Social Security, it is critical to understand how the program is financed. Since its inception, Social Security has been funded by payroll taxes. This means that that a portion of every worker’s paycheck is deposited into the OASDI trust fund, which earns interest on every deposit. This method has largely underwritten the program for decades, however, payouts eventually began to exceed tax inflows in 2009. Presently, 93% of social security payments are funded by payroll taxes while the other 7% of are paid for by the existing funds left in trust fund. However, because of demographic trends that I will address later, the surplus in the trust fund is running dry. This deficit reached $79 billion in 2014, leading the non-partisan Congressional Budget Office to predict that the trust fund will run out by 2034. When this happens, benefits will either have to drop by 20% or payroll taxes will have to increase by at least 4% to continue to fund promised payouts. This represents a worst-case scenario, as it would drastically hurt lower income workers and retirees who depend on social security for a safe retirement, largely because they would see their taxes raised and their benefits slashed.

 

The first threat to Social Security is demographic. As baby boomers enter retirement, payroll tax revenue withers and beneficiary payments grow. For example, in 1960 there were 16.5 workers paying into the system for every beneficiary. Today this figure is a meager 2.8. This trend is expected to continue until at least 2060, at which point there will be only 2 workers per every beneficiary.

These demographic woes are further exacerbated by how retirees’ payments are actually calculated. Currently, a worker’s lifetime earnings are wage-indexed, or averaged into annualized payments (after adjusting for wage growth). Although this methodology may seem fair, it ignores the fact that wage growth has historically outpaced inflation. Therefore, as wages rise in real terms, beneficiaries will receive larger payments than the equivalent rise in prices. Complicating this is the fact that experts forecast a 150% increase in benefits relative to the consumer price index (CPI) by 2090. This is by far the single biggest reason that social security becomes more expensive every year that it remains unaltered.

While these trends certainly pose difficult obstacles, there are still many ways to approach overcoming them. Republicans, both in Congress and on the presidential campaign trail, have called for Social Security to be “means tested,” which would halt benefits to wealthy retirees. Although this would slightly reduce the federal payment burden, many experts assert that it would not ensure solvency in the long run, largely because benefits are already capped for high-income earners. Many Republicans also support raising the retirement age from 66 to 70 mainly because Americans are both working and living longer. This plan is more actionable. Specifically, the CBO projected that it would eventually eliminate the 75-year funding shortfall. Still, critics of the proposal argue that it would be burdensome to lower-income beneficiaries who make a living doing manual labor because they tend to retire earlier and depend on early payments. Perhaps the most controversial GOP proposal is partial privatization of the program. Advocates cite the success of privatized programs in Sweden, Chile, and the UK, where returns are 5.3% higher on average than public plans. Opponents argue, however, that privatized plans increase the risk of lost savings in times of economic instability. Since the purpose of social security is to ensure a comfortable retirement, tying benefits to fluctuating financial markets defeats the purpose of social insurance. Therefore, even though private accounts have higher average returns, Democrats have made it a non-starter.

On the other side of the aisle, liberals have called for a progressive increase in the payroll tax. Currently, Americans with annual incomes exceeding $118,000 are only taxed on the first $118,000 they earn. This is because as later recipients, higher income individuals will not receive more than this amount back in benefits. Democrats argue the cap should be removed because it represents both “a tax break for the rich” and can help close the budget shortfall in the trust fund. Specifically, they cite that the CBO has declared that removing the cap would make the program solvent in the long run. Although this might make budgetary sense, it is politically unrealistic given that conservative politicians and economists consider it a massive tax hike on corporate income that would negatively affect unemployment. For this reason, removing the cap would be dead on arrival in a GOP-controlled congress.

Even though both parties have plans that close the trust fund gap, special interests have made raising payroll taxes or the retirement age non-starters. However, there is a plan that has gained some independent support that does not touch either controversial topic. The Tax Foundation, a non-partisan think tank, has proposed changing the beneficiary payout formula without raising taxes or the retirement age. Specifically, the institution suggests gradually shift the program from a wage-indexed a system to price-indexed one. By tying payments to the growth in prices, according to the CPI, benefits would grow at a slower rate. This would eventually make the program solvent in the long run. While seniors would see their benefits gradually reduced, many experts say this is a worthwhile tradeoff. The current trajectory of the system has proven that tying benefits to wages is unsustainable in the long run. A price-based index would directly address the shortfall and ensure social security’s stability, while not mandating tax hikes or forcing seniors to postpone retirement.

Former Speaker of the House Tip O’Neill famously referred to Social Security as the “third rail of politics,” because if anyone tried to touch it, it would kill their career. This adage has largely held true, as ensuing Congresses and presidential administrations have mostly ignored the growing insolvency of America’s favorite entitlement program. Nevertheless, our current leaders must stop kicking the can down the road or face gutting the safety net on which so many Americans depend.

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