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Opinion: Social Security Cuts Are Inevitable

For the more than 64 million people currently receiving a Social Security benefit, as well as the tens of millions of working Americans who’ll qualify for a retired worker benefit in the years and decades to come, I have some bad news — namely, the most successful social program in history may not have enough cash in its coffers to cover your full monthly payout.

Every year, the Social Security Board of Trustees releases a short-term (10-year) and long-term (75-year) outlook for the program. Since 1985, it’s been cautioning that long-term revenue collection would be insufficient to cover outlays.

Put in plainer English, for the past 35 years, the Trustees report has warned that Social Security had long-term unfunded obligations. In the 2020 report, the Trustees have forecast that Social Security will completely exhaust its $2.9 trillion in asset reserves by 2035, leaving an unfunded gap of a whopping $16.8 trillion between 2035 and 2094.

A senior man counting a fanned pile of cash in his hands.

Image source: Getty Images.

If there’s a sliver of good news here, it’s that the program doesn’t need any money in asset reserves (i.e., net cash surpluses built up since inception) to continue paying eligible beneficiaries. Two recurring sources of revenue — the 12.4% payroll tax on earned income and the taxation of benefits — ensure that Social Security can’t go bankrupt.

However, completely depleting Social Security’s asset reserves would unequivocally demonstrate that the existing payout schedule, inclusive of cost-of-living adjustments, is unsustainable. Without some form of intervention, monthly benefits to then-current and future retired workers could fall by up to 24% in 2035.

Raising or removing the payroll tax cap is the most popular solution among the public

When it comes to “fixing” and strengthening Social Security, there are three schools of thought:

  1. Raise additional revenue (through taxation)
  2. Reduce long-term outlays
  3. Use a combination of No. 1 and No. 2

In various surveys and polls conducted throughout the years, the American public has overwhelmingly favored the idea of raising additional revenue as opposed to cutting benefits in any meaningful way. In particular, when presented with a host of solutions, the majority favor the idea of raising or eliminating the payroll tax earnings cap.

Two Social Security cards lying atop a W2 tax form, highlighting payroll taxes paid.

Image source: Getty Images.

Social Security’s 12.4% payroll tax is its primary revenue generator, having accounted for nearly 89% of the $1.06 trillion collected last year. This 12.4% tax is applied to wages and income (not investment income) ranging between $0.01 and $137,700, as of 2020. This $137,700 is the payroll tax earnings cap. Any earned income above this limit is exempt from the payroll tax. In 2016, an estimated $1.2 trillion in earned income was exempt from this tax, up from just over $300 billion in 1983.

According to various proposals from Capitol Hill, this cap could be arbitrarily increased or removed in its entirety to drive additional revenue collection. Translation: The wealthy, who are less likely to be reliant on Social Security income in the first place, would be required to pay more into the system to bridge the program’s unfunded obligation gap of $16.8 trillion.

Another reason this solution is so popular is because it would only affect about 6% of working Americans. That’s because the other 94% earn less than $137,700 a year and are already paying into the Social Security program on every dollar they earn. To many working Americans, eliminating the cap would be viewed as making taxation fairer than it is now.

But I have a news flash for those of you who support a payroll tax increase to save Social Security: It won’t be enough.

Scissors cutting a one hundred dollar bill in half.

Image source: Getty Images.

Sorry, but the most popular solution won’t fix Social Security in its entirety

To be clear, raising or eliminating the payroll tax cap would absolutely put the program in better financial shape than it is now. Based on the aforementioned $1.2 trillion figure, it would add $150 billion annually to Social Security’s revenue collection and delay the projected exhaustion of the program’s asset reserves by 2035.

The problem is that raising taxes on the rich doesn’t fix the unfunded obligation problem in its entirety. It merely pushes the asset reserves depletion date out a bit further and kicks the can down the road. You may not like what I’m about to say, but Social Security outlay reductions are an inevitability.

The issue isn’t just that raising taxes on the wealthy doesn’t fully cover the $16.8 trillion shortfall through 2094 — it’s that a number of the assumptions made by the Trustees may be proved wrong over the coming decades, which would only widen the unfunded obligation gap.

As an example, for as long as I can recall, the Trustees had been counting on a fertility rate of 2.0 births per woman of childbearing age (15-44) over the long run. But in the 2020 report, this figure was reduced to 1.95 lifetime births, on average, which follows births per woman in the U.S. hitting an all-time low in 2018 and 2019. Based on the high-cost model figures provided by the Trustees, a decline in average lifetime births per woman to 1.75 (which is higher than where the U.S. finished in 2018 or 2019) would add another $3 trillion to Social Security’s funding gap.

A Social Security card lying atop a work visa.

Image source: Getty Images.

Another issue is the steady decline in net immigration rate into the United States over the past 20 years. The Social Security program relies on a steady influx of migrants, given that immigrants tend to be younger and wind up working in the labor force for decades to come. In other words, their payroll tax revenue helps to sustain Social Security and keep it solvent.

However, falling immigration rates threaten to further derail Social Security. The Trustees’ high-cost model, which assumes an average of 946,000 net migrants each year over the long term, would increase Social Security’s unfunded obligations by more than $1.7 trillion. In the most recent five-year stretch, net immigration has totaled about 954,806 people per year. 

While $16.8 trillion in unfunded obligations may sound scary, there’s a very good chance this figure is going to get much larger in the years that lie ahead. The only way to effectively tackle this shortfall is going to be through some combination of raising additional revenue and reducing long-term outlays.

Keep in mind that “reducing long-term outlays” doesn’t have to mean taking the proverbial scissors and reducing retired-worker benefits across the board. More than likely, it would take shape as a gradual increase to the full retirement age.

Doing so would require future beneficiaries, such as millennials, to either wait longer to receive their full monthly payout or accept a steeper reduction if claiming early. No matter their choice, the lifetime benefits paid to future generations will be lower, thereby saving the program money over the very long term.

It could still be quite some time before Congress is forced to take action and fix Social Security, but expect some form of outlay reduction to be an inevitable — and needed — part of the solution.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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