Recently, the Social Security Administration announced that its cash reserves will run out in 2034, a year earlier than earlier projected. When this happens, the agency will continue to pay benefits based on its ongoing tax revenue. This will require cutting benefits to about three-quarters of their current levels. To preserve full benefits, the agency suggests, Congress can raise the Social Security payroll tax by approximately 4% on all earners, or it can raise the payroll tax cap so that high-earners pay Social Security taxes on more of their income.
This has led to significant confusion over the actual state of Social Security. Or, to put it in the language of the Social Security Administration’s Chief Actuary, “[t]he concepts of solvency, sustainability, and budget impact are common in discussions of Social Security, but are not well understood.” This was true in 2010. It’s true today. And it’s the context in which Americans should understand the recent question of whether Social Security will run out of money.
Here’s what’s going on.
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Social Security’s Coffers Are Running Dry
On Friday, March 31 the Social Security Administration released its latest report on the future financial status of the Social Security Program. The headline-grabbing feature of this report came early on, with the announcement that the SSA has enough cash on hand to continue making full payments for another 10 years. In 2034, the agency expects that its trust fund will run out of money. At this point, unless something changes, it will have to reduce benefits to approximately 77% of their established level.
This is not because the program has spent years running a deficit. In fact, at time of writing the Social Security program is quite well funded. Instead, this is a projection based on the future needs of an aging workforce.
The information is not exactly new. Policymakers have known that Social Security would run out of money around the 2030’s for decades now. However the program has recently crossed an important threshold that adds urgency to the debate. In 2021, for the first time in decades, Social Security collected less in taxes than it owed in benefits. This forced the program to begin making regular payments from its trust fund, a process that will continue for the foreseeable future.
Congress reformed Social Security the last time it faced a similar crisis in 1983. Then, the SSA projected that it would remain solvent through 2050. Analysts quickly adjusted those estimates down, and by the 1990’s it was widely accepted that Social Security would run out of cash sometime between 2029 and 2037, when most of the baby boomers had entered retirement. In fact, for more than 15 years the Social Security Administration has been consistent in predicting a shortfall between 2034 and 2037.
While this has been often reported as chronic shortfalls in the Social Security program, that was not the case. For about 40 years, Social Security collected more in taxes than it paid in benefits. Each year the program puts this overage in a fund known as the Social Security Trust, a collection of cash and Treasury assets that the program can draw on when it needs money.
The growth of this fund peaked in 2007. Since then the fund has continued to grow, but more slowly as the gap between Social Security’s revenue and its payments has steadily closed. In 2021 the program ran an overall deficit for the first time since the 1983 overall.
That trend continued in 2022, with Social Security spending about $1.244 billion in benefits and collecting about $1.222 billion in taxes and interest. The program made up the difference with money from its trust fund. This is not a problem for any given quarter, or even any given year; that’s why the trust fund exists. But at current tax rates, Social Security will continue relying on its trust fund to pay benefits for years to come. As of the agency’s most recent analysis, this will exhaust the trust fund entirely in 2034.
Demographic Dynamics Are Squeezing the Social Security Trust Fund
The reason for this shortfall has to do with demographics.
In recent years the baby boomer generation has begun aging into retirement, creating a surge in demand for Social Security benefits. This has coincided with an overall decline in American families. Households are having fewer children each year, and together this has led to an upward shift in the population. As the SSA noted in its 2010 financial report, America’s workforce is aging “not because we are living longer, but because birth rates dropped from three to two children per woman.”
This is a problem for Social Security because of the nature of this program. Contrary to popular belief, the Social Security program does not return or refund the money that retirees contributed during their working life. Instead, it is a straightforward government transfer program, where current workers pay taxes to support the program’s current benefits. Years ago, Social Security could count on four or five workers paying taxes for each retiree. Today, that ratio is almost two-to-one, leaving far less revenue to pay for each retiree’s benefits.
What Are Possible Solutions to the Social Security Shortfall?
Most experts agree that preserving Social Security benefits will require some combination of tax increases and benefit cuts. However, they disagree on how to structure this.
In stark terms, the Social Security Administration recommends that if Congress waits until 2034 to act, it will have three options: Increase the payroll tax by 4.15%, permanently reduce benefits by 25.2% across the board, or enact a combination of the two approaches.
Many economists have suggested other approaches to this issue. In particular, many suggest that Congress should address this by raising the payroll tax cap so that higher-income households pay more in Social Security taxes.
The payroll tax cap has been an issue of repeated debate. Workers only pay Social Security taxes on the first $160,200 of their income. After that, the tax falls off. This is what’s known as a “regressive” payroll tax, in that the share of tax as a proportion of income is higher for lower-earners than for high-earners.
Advocates of raising the payroll tax cap argue that it would allow Congress to raise more revenue for Social Security without having to impost a flat-tax increase on every household. Other analysts suggest that it could address a potential quiet issue that has dragged down Social Security’s finances: Income inequality.
With ordinary income taxes, new wealth and income almost always generates more revenue for the government. If someone gets a raise at work their income taxes almost always go up, regardless of how much they make. However this is not true of a capped payroll tax. With Social Security taxes, when someone who earns more than $160,200 gets a raise, the program doesn’t see any new revenue.
This has created a potential financial concern given the disproportionate nature of income gains in the United States over the past 40 years. Most new income has accrued to the top 20% of earners over this period, and particularly the top 1%. Most of those households already earn more than the payroll tax cap, meaning that Social Security has seen relatively little revenue gains from that new wealth and income.
This, along with arguments rooted in economic equity, has led many economists to suggest that Congress should raise or eliminate the payroll tax cap as a potential solution to the program’s shortfall.
In the meantime, the Social Security Administration has confirmed what it has known since the 1990s. Reduced birthrates and the retirement of the baby boomers has put additional stress on the program’s finances. By 2034, it will not have enough money to keep making full payments.
In 2034, Social Security will run out of money to keep paying its full benefits. This is a problem that the program has known about for decades, but addressing it will require fairly urgent action.
Social Security Tips
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