For most retirees, Social Security is an indispensable financial lifeline that helps make ends meet. For a significant percentage of the current working population, this statement also applies when they retire.
But when viewed as a whole, Social Security can be a complex, confusing, and potentially intimidating program for the American public to try to understand. I can change that.
Today we are going to break down three complex topics that are explained in plain English:
- How America’s Best Retirement Program Got Itself Into Financial Trouble.
- The Social Security changes that Democrats and Republicans want to make to bolster the program.
- Why a solution to Social Security’s problems is a long way off.
Social Security faces a $20.4 trillion cash shortfall
Since 1940, Social Security has been offering eligible employees a monthly retirement benefit. For the vast majority of those years, the program has generated more revenue than it has paid out in benefits.
Where does Social Security get its revenue from, you wonder? About 90% of the money it brings in comes from the 12.4% payroll tax on wages and salaries. This payroll tax is paid on income earned between $0.01 and $147,000 in 2022, although the cap will increase to $160,200 next year.
The remaining 10% of annual income comes from a combination of taxing Social Security benefits for recipients earning above certain income thresholds and the interest earned on bonds held by Social Security trusts. The extra income that Social Security brings in most years over what it pays out in benefits is legally required to be invested in special low-risk government bonds that pay interest.
The problem for Social Security is that numerous demographic shifts are increasing payouts much faster than revenue growth. As a result, Social Security was in deficit in 2021. This deficit is expected to increase in size every year.
These demographic shifts include the continued retirement of baby boomers, a slowdown in legal net immigration to the US, historically low birth rates, lower interest rates (which reduce the interest on the bonds held by Social Security) and rising income inequality.
According to the 2022 Social Security Board of Trustees report, the program expects a cash shortfall of $20.4 trillion between 2022 and 2096. While this is only an estimate, the trustees take into account all the demographic variables described above, as well as costs. -of-life adjustments (COLA) are passed on to beneficiaries most years so that their payouts keep pace with the rising price of goods and services (known as inflation).
If lawmakers in Washington DC don’t do anything to strengthen Social Security, the trustees believe a 23% overall cut in benefits by 2034 may be necessary for the Old-Age and Survivors Insurance Trust (OASI) to make payments without some form of further cuts until 2096. The OASI pays benefits to more than 48 million retired workers and about 5.8 million survivors of deceased workers.
How Democrats and Republicans Want to Boost Social Security
Now that you better understand why Social Security is in big financial trouble, let’s take a look at how lawmakers are proposing to fix the program.
The Democrats’ Proposal
There are only two ways to approach an estimated $20.4 trillion cash deficit: increase additional revenue or decrease costs. Democrats prefer the former.
Democrats’ core proposal in Congress is to raise payroll taxes on high-paid workers. As noted, wages and salaries above $147,000 are exempt from payroll taxes in 2022.
Prior to his November 2020 election to the Oval Office, Joe Biden proposed a plan that would reinstate the 12.4% payroll tax on earnings earned above $400,000. Meanwhile, income between $147,000 and $400,000 would remain exempt from payroll taxes. To provide some context, more than $1 trillion in earned income escapes Social Security payroll taxes each year.
The other Social Security proposal put forward by Democrats is to change how annual cost-of-living adjustments are calculated.
Since 1975, the Consumer Price Index for Urban Wages and Employees (CPI-W) has been used to determine annual inflation and to assign COLAs. Democrats prefer the Consumer Price Index for the Elderly (CPI-E). While the CPI-W tracks the spending patterns of working-age Americans who do not usually receive Social Security benefits, the CPI-E would specifically track the spending patterns of seniors, who make up the bulk of program recipients. The end goal here is to increase annual COLAs by using an index that better reflects the inflation experienced by seniors.
The Republicans’ proposal
On the other side of the political aisle are Republican lawmakers, who collectively believe that cutting spending on programs will strengthen Social Security in the long run.
The main change Republicans would like to see made is a gradual increase to the full retirement age (FRA). A person’s FRA is the age at which they qualify for 100% of their Social Security retiree benefits. For anyone born in 1960 or later, their FRA is 67.
Taking your payment before you reach FRA means you accept a permanent lifetime discount (ie you don’t receive 100% of what you would owe with FRA) on your monthly payout. Meanwhile, waiting until after FRA can increase your monthly payout by up to 24% to 32%, depending on your year of birth.
What the GOP has proposed is to gradually increase the FRA to as high as 70. If the FRA were to be increased, workers would either have to wait longer to receive their full retirement benefit or file a claim earlier and accept a permanently reduced benefit. Whatever their choice, it would ultimately lead to a lower lifetime benefit payment.
The other big change proposed by Republicans is to switch from the CPI-W to what is known as the Chained Consumer Price Index. The Chained CPI takes into account the idea of substitution – trading for a comparable cheaper good or service. In other words, if the price of ground beef increased by 60% in the past year, consumers could trade for a cheaper source of protein, such as pork or chicken. Using the Chained CPI as an inflationary measure of Social Security would almost certainly result in lower annual COLAs, which would work to reduce how much money the program pays out each year.
Here’s Why a Social Security “Fix” Hasn’t Happened Yet (And Maybe Not For A While)
To be clear, Social Security’s failings have never been lacking in resolutions on Capitol Hill. Nevertheless, Social Security legislation has been stagnant for decades, with the last major overhaul of the program under President Ronald Reagan in 1983. The reason for this ongoing stalemate is twofold.
For starters, both the Democratic and Republican solutions are working to strengthen Social Security, which is the biggest problem. Legislators find it unnecessary to find common ground with their opposition if they have a solution that would make Social Security financially stronger.
However, both solutions also have their shortcomings.
For example, it would be decades before the GOP’s proposal to raise the full retirement age would lead to meaningful cost savings. Since the OASI is expected to have exhausted its excess reserves by 2034, this does not bode well for the program in the short term.
As for the Democrats’ plan, raising payroll taxes alone won’t fill the estimated $20.4 trillion cash shortfall through 2096. Furthermore, it can be argued that the wealthy pay all their fair share of social security, since they would not see a cent extra in benefits despite higher taxes.
The second reason why a resolution is likely to be many years away has to do with the makeup of Congress — especially the U.S. Senate. To change Social Security, 60 “yes” votes are needed in the Senate. It has been more than four decades since both parties had a supermajority of 60 senate seats. This means Democrats need some form of Republican support, or vice versa, to pass legislation. That just wasn’t possible, given how ideologically separated the two parties are.
If there’s a silver lining here, it’s that lawmakers have a history of working together in the eleventh hour. That’s what happened in 1983, and it could very well happen again as the Social Security OASI approaches its wealth reserves. But in the meantime, expect little progress on social security legislation, despite clear indications that the program needs urgent adjustment.