Why Social Security will not collapse and the four actions government can take to make sure it won’t.
In this episode you’ll learn:
- What does Social Security cost per year and how is it funded.
- How soon will the Social Security trust funds be depleted.
- What are the ways to stabilize the Social Security program.
- How productivity increases will help determine the future of Social Security.
Will Social Security Go Bankrupt?
The vast majority of Americans will be highly dependent on Social Security in retirement, yet 77% of workers are worried that Social Security will run completely out of money by the time they retire according to the Transamerica Center For Retirement Studies.
Let’s look at the numbers to see if we should be concerned.
How Social Security Is Funded
Social Security is a U.S. government program for providing retirement and disability payments to its citizens. It was established in 1935, and it is by far the largest annual expenditure by the U.S. federal government with an annual program cost of more than $900 billion or approximately 25% of federal spending.
61 million individuals receive Social Security benefits of which 83% are retirees or their spouse and children. 17% of recipients are disabled workers or their spouse and children.
Social Security is funded primarily through payroll taxes at a rate of 12.4% of individuals’ earnings up to a maximum earnings level of $118,500 in 2016. Employers usually pay half the amount with employees paying the other half. Self employed workers pay the entire 12.4%.
94% of Social Security funding comes through payroll taxes with the remaining coming from income taxes on some Social Security benefit payments.
Social Security retirement and disability benefits are paid out of two trust funds, one for retirement benefits and the other for disability benefits.
Over a period of decades, revenue from payroll taxes exceeded benefit payments so the reserves were invested in U.S. Treasury Special Obligation Bonds with interest from those securities credited to the trust funds.
As of December 2016, the trust funds had a balance of $2.85 trillion invested in Special Obligation Bonds issued by the U.S. Treasury that pay an average annual interest rate of about 3%.
A Pay As You Go System
The reality is Social Security is a pay as you go system as money flows into the trust funds from taxes and flows out to pay beneficiaries.
The excess gets spent by the federal government on other programs. The trust funds are just accounting entities that hold IOU’s from the federal government in the form of Special Obligation Bonds.
In 2010, the amount of Social Security outlays exceeded the amount of revenue received excluding interest for the first time. In fiscal 2016, outlays were approximately 7% greater than non-interest revenue.
If we include interest on the Special Obligation Bonds, the Social Security trust funds had $957 billion in receipts in 2016. Expenditures were $922 billion. That means trust fund balances got bigger by about $35 billion between 2015 and 2016.
Depleted Trust Funds
The Congressional Budget Office estimates that the disability trust fund will be depleted by 2022 and the retirement benefits trust fund by 2030.
The Social Security Trustees conducted a similar analysis and estimated the trust funds combined won’t be depleted until 2034.
Under current law, the Social Security Administration can only make benefit payments out of the trust funds so once they are depleted, beneficiaries will only receive payments in a given year that matches the amount of tax revenue paid into the trust funds.
The CBO estimates scheduled outlays for Social Security programs will rise from 5.0% of gross domestic product (GDP) in 2016 to 5.9% in 2026 and 6.3% in 2046.
Non-interest revenues are expected to be 4.6% of GDP in 2016, 4.4% in 2026 and 4.3% in 2046.
If Congress makes no changes to Social Security programs then both outlays and revenues would be equal to each other at around 4.3% of GDP.
The estimated gap between scheduled outlays and non-interest revenues grows from 0.4% of GDP in 2016 to 2.0% of GDP in 2046.
Social Security Cuts
Would Congress really cut retiree benefits when the trust funds are depleted?
That seems highly unlikely as it would be devastating to retirees and throw the country into a deep recession.
How severe would the benefit cuts be if Congress makes no changes to the program?
The CBO estimates a worker born in the 1980s who retires at age 65 would have their initial Social Security annual retirement benefit reduced by approximately $6,000 or 33% from $24,000 to $18,000 in 2016 dollars if no changes are made to the program.
That means Social Security would only replace 32% of the average worker’s annual pre-retirement earnings down from 45% before the cuts.
For the lowest income quintile, Social Security would go from replacing 80% of pre-retirement income to 58%.
Congress could close the gap between promised benefits and expected receipts by raising additional tax revenue, such as applying the 12.4% payroll tax to an individual’s entire earnings instead of earnings only below the current ceiling of $118,500.
Such a change would mean the top quintile of earners would pay significantly more into the Social Security system than they would receive in benefits.
Currently, according to the CBO, the top income quintile who were born in the 1980s are expected to pay $665,000 in taxes toward Social Security while receiving expected benefits of $664,000.
That compares to the average worker born in the 1980s who is expected to pay $308,000 in payroll taxes for Social Security while receiving expected benefits of $423,000.
Most retirees receive more in Social Security benefits than they contribute in taxes.
Create Money or Borrow
An alternative approach to cutting benefits or raising taxes is for the federal government to change the rules to allow Social Security to run an annual deficit.
This could be accomplished by having the government continue to spend the money on benefits. The federal government as the issuer of the nation’s currency has the ability to create money by simply crediting the recipients’ bank accounts if Congress elects to do so.
Money is digital and the federal government does not have to wait until money arrives before it can spend if it chooses to do so. It can simply spend by crediting Social Security recipients’ bank accounts.
Of course, in practice the federal government does wait until money arrives before it spends and deficits are covered through government borrowings.
Since 2010, the federal government has been borrowing to cover the shortfall between Social Security receipts and the beneficiary payments. The interest on the Special Obligation bonds held in the trust funds are essentially paid with government borrowings as it issues new U.S. Treasury bonds each year to cover the federal budget deficit.
The federal government could continue to do that as long as budget deficits including the Social Security deficit are modest as they will be according to CBO projections.
Why? Because what matters is whether in the coming decades the U.S. economy is sufficiently productive to produce the goods and services retirees need to live on that they can buy with their Social Security benefits.
The Federal government’s constraint in its ability to create money and spend is whether there are ample goods and services to be bought. If there are not, then inflation will rise.
The true risk to Social Security is not government finances but whether the private sector is sufficiently productive to produce ample goods and services for a growing retiree and non-retiree population.