Doing Nothing is Not a Plan to Fix Social Security

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Wednesday, July 19, 2017
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25 Fiscal Lessons

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Social Security is the largest program in the federal budget, accounting for almost 24 cents out of every dollar spent by the government in 2016. The program consists of two main components: Old Age and Survivors Insurance, which provides benefits to 49 million retired individuals and their dependents, and their survivors; and Disability Insurance, which pays benefits to 11 million workers with disabilities and their dependents.

Social Security is partly funded by a 6.2 percent payroll tax paid by employees and an equal amount by their employers on wages up to a cap known as the taxable maximum ($127,200 in 2017). Before 2010, revenue from payroll taxes was sufficient to cover the cost of benefits. But since then, Social Security has consistently spent more than it has received from payroll taxes  – and the gap is only going to grow larger in the future.

The reason for Social Security’s long-term shortfall is changing demographics. There were five working-age adults paying into the system for every individual receiving benefits in 1960; today that ratio is close to 3 to 1. And by 2034, it will fall further to roughly 2 to 1. When the ratio of taxpayers to beneficiaries falls, taxes either need to be increased or benefits need to be reduced to close the ensuing financial shortfall.

Some believe that this can wait several years because of the program’s “trust fund,” which tracks the balance between incoming revenues and outgoing spending and enables previous years’ surpluses to be credited towards future deficits. The combined Social Security trust funds for Disability Insurance and Old-Age and Survivors Insurance won’t technically be exhausted until 2034. This logic, however, is deeply misguided. Between now and the projected trust fund insolvency date, Social Security is projected to spend $3 trillion more than it will raise in dedicated revenues. Because the trust fund is entirely invested in government bonds, and the federal government is already running deficits, the government will have to borrow from the public to finance that shortfall.

Once the trust fund is exhausted, current law would require an across-the-board benefit cut of roughly 23 percent. Such a sudden and steep benefit cut would significantly harm most retirees, who rely on Social Security for substantial parts of their incomes. This is particularly true for beneficiaries with fewer resources, in part because the benefit formula favors them in terms of what they receive relative to what they paid into the system as workers.

Whether policymakers choose to close Social Security’s shortfall with tax increases, benefit reductions, or a combination of the two, it would be best to phase them in gradually and give beneficiaries and employers time to adjust their finances. Doing nothing, and allowing a crisis to threaten the retirement security of tens of millions of Americans, is not an acceptable plan.