Don’t Just Panic Over Social Security’s Worsening Finances- Do Something About it

It doesn't matter how you look at it: The headlines on the future of Social Security are scary:

• For the first time in history, in 2010 Social Security paid out more money in benefits than it collected through payroll tax;
• The extra money being set aside in the Trust Fund for the past 30 years will be used up by 2033- three years earlier than projected just a year ago;
• In order to pay benefits promised over the next 75 years Social Security needs $8.6 trillion;
• The payroll tax would have to immediately be raised by 2.67 percentage points to close the funding gap over this period.(1)

And yet, the National Academy of Social Insurance (NASI) and the Center for Retirement Research (CRR) at Boston College- two of the most respected and non-partisan think tanks in the country- have described Social Security’s financial problems as “manageable.” As in, we can fix this. 

So What’s New?

In their annual report to Congress last week, Social Security’s trustees warned that the system was running a deficit. That is, the current amount collected from workers would not sustain the benefits promised to retirees over the next 75 years. But here's the thing: They’ve been issuing this same warning since 1983. Although the deficit increased to 2.67% from 2.22% last year, CRR director Alicia Munnell points out that the shortfall “has been around 2% of taxable payroll since the early 1990s.”

What Happened?

Numerous factors caused Social Security’s actuaries to paint a gloomier picture of Social Security’s long-term financial outlook in their 2012 projections, including the recent recession and the continued weak recovery. Both contributed to continued high unemployment, which significantly reduced the amount of payroll tax, or income, Social Security collected. Plus, thousands of baby boomer workers were forced to claim Social Security benefits earlier than planned because they weren't able to find new jobs after being laid off.

In addition, Munnell points out that in the past few years, “birth rates and legal immigration were lower.” The fact is, when you’re unemployed or uncertain how secure your income is, you’re more likely to delay the expense of having a child. And, with the nation’s unemployment rate at 8-10% for the past four years, our economy isn’t attracting a lot of foreigners looking for work. Both factors reduced the projected number of future workers available to support an aging population.

Because it was not announced until last fall, another factor the actuaries couldn’t incorporate into their 2011 projections was the large cost-of-living increase Social Security beneficiaries received this year: 3.6%.  Moreover, because benefits never go down, this increase is permanently incorporated into the cost of future benefits Social Security must pay out. (2)

Stop Blaming Baby Boomers

The increasing cost of Social Security is not the “fault” of the large Baby Boom generation. Back in the early 1980s, the payroll tax rate was specifically increased in anticipation of the time when this demographic group (born from 1946-1964) would begin retiring. The extra money collected went into the Social Security Trust Fund.  In fact, much of this money has been contributed by baby boomers themselves over the course of their careers.

So what’s behind Social Security’s funding shortfall? Take a look at the chart below:

As you can see, the cost of Social Security (which includes disability payments as well as monthly benefits paid to retirees) began to exceed the amount collected two years ago. The mass retirement of baby boomers was not a surprise--this has been expected for decades. The important thing to recognize is that even after the last boomer dies, this trend does not reverse. That is, the cost of Social Security will continue to exceed the amount collected through 2070 and beyond. Why? Because we have experienced what appears to be a permanent decline in the birth rate in this country coupled with a steady increase in life expectancy. 

As a result, there will be fewer workers paying into the Social Security system and their contributions will be supporting retirees who are living longer than ever before.  Today, there are roughly 35 beneficiaries for every 100 workers. In the future this ratio will be 52:100.  In order to continue to pay benefits at today’s level, adjustments will have to be made- either benefits will have to be reduced, or the amount of tax collected will need to increase.

Sharing the Cost

We’re not talking about giving away half your paycheck. Today, the Social Security, or payroll, tax is 12.4%. If you want to solve the shortfall just by tinkering with the payroll tax, we could “fix” Social Security by raising it this to 15.07%.  Employers and employees would share the cost equally. Let me re-phrase this:

If employees and employers each kicked in an additional 1.34%, we could make Social Security solvent for the next 75 years without cutting benefits.

In other words, everyone shares the pain, but everyone gets what they’re expecting. No reduction in benefits required. If your salary is $50,000, you’d pay an additional $670 more per year. I think most folks would say this sounds rational, fair and simple. In fact, Virginia Reno, vice-president for Income Security at the National Academy of Social Insurance, says that survey after survey shows there is widespread support for Social Security from the American public, with a majority consistently saying they would be willing to pay more in order to retain the system.

There are a number of other ways to tweak Social Security and close the shortfall, says Reno. For instance, some advocate lifting “the cap on earnings subject to Social Security tax and modestly increasing the benefits” for higher earners. Presumably, giving higher-income folks who would be hit hardest by this approach a little bigger benefit might make it more palatable. According to Reno, this would eliminate 90% of the current funding gap.

“The best thing to know is that policymakers can fix it. It’s not that hard. In the past they’ve waited until the 11th hour, but it’s better not to.” The longer you postpone dealing with the problem, the more drastic the solution has to be.

Preserving the Trust Fund

Reno says it’s especially important that we fix Social Security before we start reducing the principal in the Trust Fund. There is no cash in the Trust Fund--it’s been “borrowed” by Congress to fund other government spending. In its place are special bonds issued by the U.S. Treasury. “Fifteen percent of the income Social Security receives comes from the interest on the bonds,” according to Reno. “This means we only have to finance 85% of the [financing] gap. If you spend down the Trust Fund to zero, you need to raise 100% from taxes.”

Healthy Economy = Healthier Social Security

Want to know the best way to improve Social Security’s financial outlook? Get our economy growing again! Both the White House and some members of Congress continue to blame either: 1) the former administration, or 2) the private sector for the recession and ensuing lackluster recovery. (If indeed you can even call it that, with unemployment stuck at 8% or higher for the past four years.) In fact, misguided policies and bad laws have made businesses hesitant about expanding and hiring new workers. When more Americans are working, Social Security collects more payroll tax. It’s as simple as that. This won’t completely solve Social Security’s financial issues, but it would sure help.

1. All numbers referenced in this column are based upon the “intermediate” assumptions in the 2012 Trustees Report, http://www.ssa.gov/oact/tr/2012/tr2012.pdf

2. “Reader friendly” summaries of the lengthy Trustees report can be found at: http://www.ssa.gov/oact/TRSUM/index.html, and  http://crr.bc.edu/briefs/social-security%e2%80%99s-financial-outlook-the-2012-update-in-perspective/,

Ms. Buckner is a Retirement and Financial Planning Specialist and an instructor in Franklin Templeton Investments' global Academy. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content. 

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