Capitol Hill had a lot on its plate in the last few months of 2021. In addition to the infrastructure and social spending bills, government shutdown and debates surrounding raising the debt ceiling were some of the most pressing items that kept lawmakers busy throughout the fall. On final days of 2021 and after a few political showdowns around the issue, Congress narrowly approved $2.5 trillion debt limit increase – Senate 50 to 49 and the House 221 to 209 along party lines – as it has done about 80 times in the past 60 years. The reason is simple: having failed to do so would have been devastating for the U.S. as well as the global economy.
In the words of Secretary Yellen, not raising the debt ceiling and a subsequent U.S. government default would mean that “in a matter of days, millions of Americans could be strapped for cash…Nearly 50 million seniors could stop receiving Social Security checks for a time. Troops could go unpaid. Millions of families who rely on the monthly child tax credit could see delays. America, in short, would default on its obligations…A default could trigger a spike in interest rates, a steep drop in stock prices and other financial turmoil,” and economic chaos at the global level.
Raising the debt ceiling will undoubtedly be good news for more than 64 million recipients of Social Security payments, who will continue receiving their checks on time for another year. However, raising the debt ceiling year-after-year will not effectively address the increasing challenges facing the Social Security System. The future looks grim for retirees, disabled seniors, and their families. The Old-Age, Survivors, and Disability Insurance (OASDI) program, commonly known as Social Security, is facing financial troubles, and is estimated to run out of reserves in just 12 years.
Social Security is facing a financing crisis
The Social Security system’s cash flow has been negative since 2010. That means the program has distributed more in social security benefits than it has collected in social security taxes, as large cohorts from the baby-boom generation started to retire. As a result, the United States Treasury borrowed from financial markets to redeem Social Security trust fund securities. Estimates suggest that the program’s cash flow will remain negative for the next decade, leading to the depletion of its current $2.9 trillion reserves in the next decade.
Once the reserves run out, the benefits will be capped at the level of social security taxes received on annual basis. Without significant reforms, in just 10 years, the eligible beneficiaries — more than 80 million retirees, survivors of deceased workers, and disabled workers and their dependents — will receive less than 79 percent of the scheduled social security benefits they were promised. The longer-term outlook is even grimmer: the 75-year present value of the fiscal projection of Social Security and Medicare shows a $26.7 trillion and $54.9 trillion deficit.
The financial troubles of the Social Security and Medicare systems primarily stem from an aging population and declining employment to population ratio in the United States. In the past two decades, the share of population ages 65 and above increased from 12 to 17 percent, while the share of people ages 0-14 — future workers — declined from 22 percent to 18 percent (Figure 1). During the same period, the employment-to-population ratio declined from 65 to 59 percent — 61 percent before the onset of the COVID-19 pandemic (Figure 2).
Delaying substantive reforms will only exacerbate the crisis and increase the cost of future reforms
The cost of inaction will only rise the longer Congress waits to reform the Social Security systems. In 2010, the Trustees of the Social Security trust funds estimated that the reserves would be depleted by 2037 and the 75-year shortfall was equivalent to 1.92 percent of payroll. Only ten years later, in 2020, the depletion date was reduced to 2034 and the 75-year shortfall was equal to 3.21 percent of the payroll (Figure 3).
Considering the aging population, longer lives and retirements, fertility rates lower than the replacement rate, and the shrinking labor force participation rate in the United States, substantive reforms must be implemented immediately. A combination of the following reforms would make the Social Security system sustainable:
- Increasing social security tax rates: The Social Security tax rate is currently set at 12.4 percent and divided equally between the employee and employer. Fiscal Year 2020 estimates suggest that an increase of three percentage points in payroll tax would cover the fund’s shortfall over the next 75 years.
- Increasing or removing the income cap for social security tax: Currently, social security taxes are paid for incomes up to $142,800. In other words, in 2021, only 84.5 percent of all earnings will be subject to social security tax, while in 1982 this figure was around 90 percent of all earnings. Collecting social security tax on 90 percent of all earnings would reduce the 75-year financing shortfall of social security by around 20 percent. Moreover, if all earnings were subjected to social security tax, the program would remain solvent for over 40 years.
- Raising the retirement age: Currently, the full retirement age (FRA) is between 66 and 67 years old depending on the birth year of a worker. However, current social security rules allow workers to receive retirement benefits starting at age 62 (early eligibility age or EEA). Increasing the FRA and EEA by three months per year until it reaches 69 years old would eliminate 26% of the system’s projected shortfall in the next 75 years.
- Increasing the number of workers: With a current worker-beneficiary ratio of 2.6, the Social Security system is facing a negative cash flow — a worker-beneficiary ratio of 2.8 is needed to keep the system solvent. It is expected that this ratio will decline further, to 2:0 by 2060, pushing the system into severe crises. Therefore, any effective Social Security reform agenda must reverse this trend or, at minimum, reduce the downward pressure on the worker-beneficiary ratio. While immigration can help to some extent, there are other options. Attracting more workers into the labor force through introducing worker and family-oriented policies — such as high quality and affordable early education and child-care programs — is a more effective way to reverse the downward trajectory in the worker-beneficiary ratio.
Public opinion varies significantly around Social Security reform, making any changes to the system a challenging and politically charged topic in Washington. However, lawmakers on Capitol Hill only have a few years to restore balance and longevity to the system. Let’s not forget that the current estimates for the shortfalls are based on normal scenarios and do not take into account the negative shocks of future recessions, natural disasters, and crises such as the current pandemic, which is estimated to have reduced the Social Security exhaustion date by four years. Congress must act now.