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My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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  • Writer's picturetim@emorningcoffee.com

Social Security: crash and burn?

I have been wanting to look more closely at Social Security for some time since this important federal retirement program is facing a troubled future. More selfishly perhaps, I will one day be eligible for benefits and would very much like to collect what I believe I am “owed” since I have paid a good amount of social security taxes over the years. By “troubled future” of Social Security, I am referring to the reality that should reform not occur in the coming years, the Social Security trust fund assets – currently around $2.8 trillion – will be entirely depleted by around 2033. Should this occur, retirees’ social security benefits would be reduced by around 20% to 25% according to several articles I have read, including one written by the Social Security Administration itself.


For those readers that are not familiar with US Social Security, it is the program in the US which was established in 1935 during the Great Depression to provide payments to Americans that reach retirement age. Since its formation in 1935, the program has been expended to include payments to survivors of deceased workers (1939) and payments to workers who become disabled (1956). State-sponsored retirement plans exist in most developed countries, including the UK (the statutory state pension system) and France (the mandatory state pension provision), although I do not know exactly how these are similar to or different from Social Security.


When I started to research Social Security in order to write about it, I came across so much information that I quickly concluded there was nothing I could really add to what is readily available on-line, including from sources like:

These are just a few of the many sources you can access on-line to learn about Social Security. Rather than regurgitate what you can read yourself, I wanted to focus on two specific topics in this article:

  • Highlights of the Social Security program for those less familiar with how it works, and

  • The expected funding shortfall that is likely within 10-12 years if reform is not undertaken.

Social Security: how it works

Social Security is a “pay as you go” plan. This means contributing workers are either providing contributions in the form of payroll taxes to a social security trust fund which is earmarked to pay future retiree benefits, or they are paying benefits to retirees now. In other words, there are no individual accounts where a worker’s social security taxes are ring-fenced, set aside for their future. Rather, it is a mix of payroll taxes from workers, trust fund assets and earnings on these trust fund assets that fund the benefits of current retirees.


After being signed into law in 1935, Social Security officially started in 1937. For most years until the mid-1970s, payments into the system from workers’ taxes exceeded those flowing out of the system to pay retirees – see here. Starting in 1975, the Social Security program experienced seven consecutive years in which total inflows (mainly payroll taxes) were insufficient to pay retiree benefits, leading to net trust fund outflows. Social Security trust fund assets were reduced from $45.9 billion at the end of 1974 to $24.5 billion by the end of 1981. The net outflows were gradually depleting the Social Security trust, and this eventually inspired a bipartisan response from Congress culminating in the passage of the “Social Security Reform Act of 1983” (details here). This Social Security reform act did several things, including:

  • adding federal workers (and their tax contributions) to the program,

  • increasing the full retirement age from 65 to 67 (phased in through 2022), and

  • taxing social security benefits.

The Social Security Reform Act of 1983 restored the Social Security program to solid footing. In the ensuing years, the Social Security trust fund increased each year, reaching $2.9 trillion by the end of 2020, although it has just recently started to decrease again. The graph below depicts the trajectory of net flows and trust fund assets since the late 1950s.



Before discussing the concerns about the future of Social Security, below are some bullet-point facts for context that will help you better understand the general parameters of the program, most of which are directly from the Social Security website.

  • There are over 66 million Americans (US population is 332 million) collecting benefits from the Social Security system, of which:

    • 52 million are retirees or their families,

    • 5.8 million are survivors of deceased workers, and

    • 8.7 million are disabled.

  • Total Social Security trust inflows in 2022 were $1.22 trillion, of which the vast majority – $1.11 trillion – came from payroll taxes. Total trust outlays – mostly retiree benefits – were $1.24 trillion. To frame the size of Social Security annual inflows and outlays, the Congressional Budget Office (here) projects that the government will receive $4.8 billion and will spend $6.2 trillion in 2023 (year ended October 2023).[1] Federal revenues and federal outlays include social security taxes (in revenues) and payments (in outlays), so you can see just how relevant social security is as a component of the US budget.

  • Social Security is a mandatory government expenditure that is not subject to annual appropriations. Interestingly in fact, 74% of the federal budget is mandatory, meaning that only $1.6 trillion (26%) of the federal budget is currently subject to annual appropriations from Congress.[2]

  • The Social Security trust fund totals $2.8 trillion currently, all of which must be invested in US Treasuries. For context, this is circa 40% of US Treasuries held by inter-governmental agencies[3]. The weighted-average interest rate earned by the Social Security trust as of July was 2.40%. The maturity profile suggests that almost all of the US Treasuries held by the Social Security trust mature on or before 2034, not at all surprising given the short remaining life of the trust. (Data is from Social Security website here.)

  • The Social Security trust fund cannot borrow money.

  • The current social security payroll tax is 6.2% for workers, with another 6.2% contributed by the employer. There is also a separate Medicare Tax of 1.45% of workers’ income, with another 1.45% paid by the employer. Both Social Security and Medicare taxes are subject to a $160,200 income cap / employee in 2023, meaning the tax rate is applied to earnings up to this level. For an employed worker, this means that 7.65% of their income up to $160,200 is paid to the US government in payroll taxes for Social Security and Medicare. In 2024, I have read (but do not know if it has been formalised) that the income cap might increase to $170,400 (here).

  • In the US, the programs under the Social Security Administration (“SSA”) employ 75,000 federal and state employees across 1,500 offices in the US and internationally. The three programs administered by the SSA, listed below, with the amount paid out in 2021:

    • Old-Age and Survivors Insurance (“OASI”): $983 bln / 55 million retirees

    • Disability Insurance (“DI”): $141 bln / 10 million beneficiaries (disabled and families)

    • Supplemental Security Income (“SSI”): $58 bln / 8 million in financial aid to the aged, disabled and blind adults and children with limited means[4]

  • Although I haven’t looked at the net effect of inflation the last two years on inflows and outlays from the Social Security trust, social security benefits are subject each year to cost-of-living-increases (“COLAs”), meaning the benefits are indexed to inflation. Obviously, this has not been working to the benefit of the plan and its payments for the last couple of years.

  • The last major reform of Social Security occurred in 1983 under the Reagan administration with the passage by Congress of the bipartisan Social Security Reform Act of 1983.

The dire situation now

Unfortunately, the actuarial reality is that without further reform, the Social Security trust fund – which started slowly decreasing in 2021 and is currently around $2.8 trillion – will be entirely depleted in 9 to 10 years. The Congressional Budget Office is projecting that trust assets will be depleted in 2032, and the Social Security Administration is projecting 2033 (here). The CBO projections are depicted in the graph below.

The good news I suppose is that the insolvency of the Social Security trust fund would not mean the bankruptcy or end of Social Security. Rather, when the trust runs out of assets, it simply means that retirees can only be paid annual benefits that are equivalent to annual incoming payroll taxes. As previously mentioned, there is currently no ability for the Social Security pay-as-you-go trust fund to borrow money. Once the Social Security trust fund’s assets are depleted, the Congressional Research Service estimates that retirees would still receive around 80% of their pre-trust fund insolvency benefits according to a study done in September 2022 (see “Social Security: What Would Happen If the Trust Funds Ran Out?”)


You might be asking how Social Security has got into this predicament. There are two simple reasons really:


Issue 1: Demographics


The number of retired Americans is increasing, people are living longer once they reach age 65 and the birth rate in the US is declining. These demographic factors have led to a sharp increase in the dependency ratio, meaning the ratio of dependents (people under 14 and over 65) to workers (age 15 to 64), as you can see in the graph below from FRED.



The number of Americans 65 has been steadily growing since well before the Social Security program began, and in fact has doubled since 1985. This means that the pool of retirees is steadily increasing each year, causing outlays to also increase. As you can see in the graph below, there is no reason to believe that this trend will abate anytime soon.

The fertility rate in the US has also been below replacement levels since the early 1970s, with a few years of exception. This effects the base of workers that provide inflows into the Social Security program, which is not growing as rapidly as needed to support the growing amount of outlays needed to provide benefits to more and more retirees.

Although the mortality rate of Americans at birth has sadly declined the last couple of years, the average life expectancy of a person in the US once they reach 65 has been steadily increasing. According to the Social Security website (here), males and females reaching age 65 in 2023 are projected to live another 17.5 years and 20.1 years, respectively. The expected lifespan has increased just over two years for each sex since 1980, and it is projected to continue to increase through 2100.


Issue 2: Politics


In an increasingly polarised and dysfunctional Congress, the sad reality is that social security is a political hot potato that neither party is willing to hardly even mention, even though it is crystal clear that the assets of the Social Security trust will run dry in several years. The fact that 2024 is a Presidential election year undoubtedly exacerbates the fear of politicians to address this issue, which is certainly an “elephant in the room”, especially since a solution would need to involve raising payroll taxes for workers, cutting benefits to retirees, or some combination of the two. As you know, older Americans are much more likely to go to the polls, and no candidate would want to raise a contentious issue and risk not getting re-elected. The US political system is simply what it is. Watching it evolve over many decades does not inspire confidence that any politician in either political party has the backbone to take leadership on much-needed Social Security reform, even though it is clear that the sooner something is done, the better.


If you are wondering what needs to be done, it is unfortunately a bitter pill to swallow no matter what path is chosen because keeping the trust solvent will take higher social security tax revenues, lower outlays (i.e. retiree benefits), or some combination of both. There are several ways these objectives could be achieved, including:

  • Higher inflows via higher tax revenues: raise the payroll tax rate (currently 6.2% for employed workers for Social Security / 12.4% for combined employee/employer contributions), raise the income cap ($160,200 in 2023), apply the tax rate more broadly to various other types of income that are now excluded, etc.

  • Lower outlays via lower retiree benefits: reduce benefits across the board or make them more means-based, raise the eligibility age for collecting reduced benefits (now 62) or full benefits (now 67), reduce / adjust / cap the COLA, change the way a retiree’s benefit is calculated (in favour of the trust), etc.

Conclusion

Writing this article at my age is painful, but something needs to be done if the Social Security system as we know it today is to continue, especially if you care about your children, your children’s’ children, and future generations to come. Even if we eventually get the reform needed to ensure that the Social Security trust is not depleted, deeper and more radical reform should be considered by some bold political leaders in Congress or a Presidential committee, e.g. abolishing the co-mingled pay-as-you-go trust and instead establishing government-sponsored individual retirement accounts. However, since politicians can hardly utter the words “Social Security reform” today, a more creative and longer-lasting fix seems entirely out of the question.

 

[1] You can do the math – yes, that is a whopping record $1.4 trillion deficit! [2] This might be considered in the context of the recent Debt Ceiling discussions, which in reality only concerned government expenses that are appropriated, not those that are mandated and not subject to Congressional approval. [3] Total US government debt is £32.6 trillion, of which $25.7 trillion is held by the public and $6.9 trillion is held by intergovernmental agencies. [4] Employees and programs are contained in Social Security Administration, Annual Performance Report 2021-2023.


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