Social Security Insolvency Is Rushing Toward Us

But there is a way to keep Social Security solvent and make it more equitable for all

By Charles Blahous

On Wednesday, April 22, the Social Security trustees issued their annual report on the program’s financial condition. The sobering contents of the report’s analysis are being underreported for at least two reasons. One is the current health crisis that is obscuring all other policy challenges. The other is that the report’s projections are already obsolete, because they do not account for the economic contraction currently underway.

Nevertheless, it would be a severe mistake to ignore the information this report contains. It shows us that, even as we are preoccupied with our immediate crises, Social Security’s projected insolvency is rushing toward us and must be dealt with soon, whether we wish to or not.

Some background is necessary to understand the situation fully. The financing frameworks of Social Security and its sibling program, Medicare, are unique among federal programs. Instead of designing these programs like so-called welfare—that is, directly financed from income taxes, with benefit eligibility conditioned on need—they function as contributory insurance. Nearly all US workers participate, earning their entitlement to these benefits via payroll tax contributions from their wages. Workers’ subsequent benefits are paid from dedicated trust funds, with these funds’ aggregate payments limited to the total revenues they receive.

Constructing Social Security in this way was a discretionary policy choice of lawmakers. They could have just as easily chosen to do it differently. And, of course, we can choose to abandon its current financing method at any time in favor of a different one.

Still, this financing basis carries certain benefits of which we should be mindful, as well as certain obligations. The framework protects participants via the societal perception that workers “earned” their benefits. This allows them to escape the frequent reassessments of eligibility rules and benefit levels typically applied to welfare programs financed from the government’s general fund.

With privilege, however, comes responsibility: these benefit protections can only continue if lawmakers ensure that total payment obligations do not exceed the program’s revenues. If lawmakers fail to do so, then we must abandon Social Security’s current financing structure, and with it, the unique political protections that program beneficiaries have long enjoyed.

We have known for decades that Social Security faces a tremendous financing challenge, which grows more difficult to solve every year we delay taking action. The long-range shortfall in the combined Social Security trust funds is currently 3.21 percent of workers’ taxable earnings.

This shortfall may sound small at first, until one realizes that it equals 19 percent of all scheduled benefits (including those yet to be paid to current beneficiaries). Closing this gap with an immediate payroll tax rate increase would require raising the rate from its current 12.4 percent to 15.54 percent. Alternatively, closing the shortfall totally on the spending side, excluding current beneficiaries from benefit cuts, would require a 23 percent reduction in future benefit claims.

These numbers are daunting enough, but consider that lawmakers have never been willing to allow tax rates and benefit levels to change so suddenly. In the real world, any changes would likely be gradual and phased in over time. For example, if corrective legislation only affects 1 percent of the benefits of next year’s retirees, gradually ratcheting up its effects upon subsequent claimants, the eventual changes would have to be much greater than 23 percent—perhaps as much as 35 or 40 percent.

We were already running out of time to repair Social Security, even before our current crisis hit. Unfortunately, press reporting on the annual projections tends to focus unduly on the seemingly distant dates of the trust funds’ projected depletions (e.g., 2035 for Social Security’s combined funds). This emphasis is dangerously misleading because it conveys the misimpression that we have much longer to act than we actually do. By the time Social Security’s combined trust funds are running dry, even the complete elimination of all new benefit claims would not prevent their depletion. By then it would be several years too late to preserve Social Security as it has functioned historically.

We don’t yet know how much worse Social Security’s situation will be after the smoke clears from our current health and economic shocks. At the very least, the current crises will absorb our precious time, during which Social Security’s problems will grow more difficult to solve. More likely, Social Security’s shortfall will swell further as unemployment surges, payroll tax revenues plunge, disability claims rise, and interest earnings fall, all of which we expect during a recession.

Of Social Security’s two trust funds, its smaller disability insurance (DI) trust fund is particularly vulnerable to near-term shocks. DI began 2020 with trust fund reserves amounting to less than eight months’ worth of benefit payments. This renders DI highly dependent on incoming tax revenues being sufficient to fund annual benefit obligations. Even a slight increase in claims, coupled with a substantial reduction in payroll tax collections, could draw down its reserves and deplete the fund in just a few years—possibly even within the next president’s term. Nevertheless, it bears repeating that the lion’s share of the Social Security shortfall, whether in DI or in old-age benefits, will face us irrespective of how much the recession exacerbates it.

To fix this problem, we will need political leadership and a willingness to compromise. The shortfall is already so large that we will need contributions from every category of reform, including eligibility age changes, moderations of benefit growth, and increased program taxes. Relying on one mechanism to the exclusion of the others is unlikely to generate sufficient improvements.

That all sounds like terrible news. Here’s the good news: the changes required are only large relative to future schedules, not past norms. We need to decelerate Social Security benefit growth going forward, but we don’t need to cut benefits from today’s levels. We need to raise future eligibility ages, but we can still choose to claim benefits earlier than previous generations did, before Social Security’s earliest eligibility age was lowered from 65 to 62. We’ll still generally be able to spend more years in retirement, collecting larger benefits, than those who came before us.

Here’s the best news of all: a Social Security system with moderated cost growth will actually be a more effective and equitable one. The current growth schedule exacerbates the program’s imposition of net income losses on younger generations, causes taxpaying worker standards of living to be depressed relative to beneficiaries’, creates work and savings disincentives, and unintended pockets of regressive income redistribution. The politics of slowing Social Security cost growth are difficult, but success would actually enable the program to serve its participants more effectively and fairly. In contrast, the worst result would be an across-the-board benefit expansion as some politicians have irresponsibly proposed, which would worsen system finances as well as its distributional inequities.

But before we negotiate solutions, we need to first understand the Social Security crisis that is racing toward us. The latest trustees’ report shows how urgent the problem had already become before COVID-19 unleashed its damage upon both health and economy. After we steer through this storm, we will have little time to waste in repairing a further weakened Social Security system.