You've probably heard the news by now: Social Security, America's top social program, is in some pretty big trouble.
Every year, the Social Security Board of Trustees releases a report examining the program's short-term (10-year) and long-term (75-year) outlook. For the past 35 years, it's been cautioning Congress that long-term revenue creation would be insufficient to cover program outlays. In the 2019 report, the Trustees forecast a $13.9 trillion cash shortfall between 2035 and 2093, using the intermediate-cost model. While this doesn't mean Social Security is on its way to insolvency (thankfully, it can't go bankrupt), an across-the-board cut to retired worker benefits of up to 23% may be just 15 years away.
That's not a very rosy outlook.
But what you may not realize is that it's not a worst-case scenario, either. Based on a number of ongoing trends that can affect the U.S. economy and Social Security, the program appears to be headed down an even worse path that could lead to steeper benefit cuts. Here are three reasons Social Security's long-term cash shortfall could grow significantly in the years to come.
Image source: Getty Images.
1. Growing income inequality
While most people have likely placed some semblance of blame for Social Security's deteriorating financial outlook on baby boomers retiring or increasing longevity, they may have overlooked the growing role that income inequality is having.
Rising income inequality is hurting Social Security two ways. First, we've seen a greater percentage of earned income exempted from the payroll tax in recent decades. While the program has three ways of generating revenue, the 12.4% payroll tax on earned income (wages and salary, but not investment income) is its workhorse. In 2018, the payroll tax supplied $885 billion of the $1 trillion generated for Social Security.
But the payroll tax is only applicable on earned income up to $137,700, as of 2020. This means that while 94% of working Americans pay into Social Security on every dollar they earn, 6% of well-to-do workers get a free pass on any earnings above $137,700. The percentage of earned income escaping Social Security has been climbing, with a little over $300 billion in earnings exempted in 1983, compared with $1.2 trillion by 2016. As the rich get richer, more of their earnings will escape Social Security's payroll tax.
The other problem here is that the well-to-do are living substantially longer than the lower-income beneficiaries that Social Security was designed to protect. Since the rich have little or no financial constraints when it comes to receiving preventive care, medical care, or prescription medicines (which is not always the case for low-income people), they're living much longer, and thereby collecting a beefier Social Security payout in the process.
Image source: Getty Images.
2. A precipitous decline in birth rates
Another problem that could seriously put a damper on Social Security's long-term outlook is the ongoing decline in birth rates.
In 2018, birth rates among women of childbearing age hit an all-time low. While birth rates do tend to vacillate from time to time, we've seen a steady decline for about a decade, resulting in this all-time low. Various publications have suggested that there are numerous reasons for this drop, including couples delaying marriage and/or having kids, fewer unplanned pregnancies, and better access to contraceptives. Additionally, memories of the Great Recession are still fresh in the minds of millennials and Gen Xers, which is another factor hurting birth rates.
The problem here is that new births are being counted on by Trustee projections to help offset the payouts to future retirees. The intermediate-cost model assumes an average of 2 births per woman of childbearing age. Meanwhile, the high-cost model assumes an average of 1.8 births per woman of childbearing age. As of 2018, we're below the average assumption for the high-cost model.
Just how much would a sustained decline in birth rates affect Social Security's long-term outlook? In examining the sensitivity of the program to fertility assumptions, the Trustees forecast an actuarial deficit of 2.78% using the intermediate-cost model (i.e., an average of 2 births per woman). This actuarial deficit describes how much payroll taxes need to go up right now for all working Americans to cover the expected cash shortfall, and leave a full year of outlays in reserves, by 2093. But using the high-cost model yields an actuarial deficit of 3.22%. This would equate to trillions of dollars of additional cash shortfall for the program in the long run.
Image source: Getty Images.
3. Lower net immigration into the U.S.
Last, but not least, we've witnessed a significant decline in net immigration into the United States. According to data from the St. Louis Federal Reserve, trailing five-year net immigration trends show a near-halving in migrants entering the U.S. over the past 20 years.
While there are undoubtedly some folks questioning whether immigration is a positive or negative for Social Security, there's absolutely no question from the Trustees report that it's a long-term positive. That's because most immigrants into the U.S. tend to be younger, which means they'll spend decades in the workforce contributing to Social Security via the payroll tax. The program counts on a steady stream of net immigration, on top of new births, to help offset older workers leaving the labor force and becoming eligible for benefits.
Similar to how the Trustees examined the impact of various birth rates over the long run, they've also looked at how immigration rates can impact the program. An average annual net immigration rate of 1.265 million people yields the aforementioned 2.78% actuarial deficit over the next 75 years. However, the actuarial deficit climbs to 3.03% if annual net immigration declines to just an average of 949,000. This is closer to where the U.S. has been on an annual basis in recent years, and it, too, could increase the program's long-term cash shortfall by the trillions of dollars.
Once again, take solace in the fact that Social Security isn't going bankrupt. But also understand that the bleak picture offered for it is probably going to get a lot uglier in the years to come.
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January 25, 2020 at 06:06PM
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3 Reasons Social Security Is Headed for a Worst-Case Scenario - The Motley Fool
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