2 Reasons Social Security Is Expected to Run in the Red 4 Years Earlier Than Previously Forecast
Social Security plays a vital role in providing a financial foundation for our nation's retired workforce. According to the Social Security Administration, just over three out of five aged beneficiaries currently relies on their monthly benefits to account for half of their income. This income is responsible for keeping millions of elderly Americans out of poverty.
But in spite of the program's obvious importance, Social Security is nevertheless facing imminent disaster.
America's top social program is in trouble
Each and every year, the Social Security Board of Trustees analyzes the short- and long-term outlook for the program. In layman's terms, it looks at the 10-year and 75-year outlook and makes projections as to the health of Social Security given current and projected variables.
Since 1985, lawmakers in Washington have known that Social Security was in trouble. That's because in every year since 1985, the Trustees have identified a point within the 75-year time frame at which Social Security's asset reserves are forecast to run out.
Now, understand that Social Security can and will operate just fine without any excess cash in its coffers. Though the program will say goodbye to one of its three sources of revenue (interest income) should its asset reserves be depleted, it's supported by the 12.4% payroll tax on earned income of up to $128,400 (as of 2018) and the taxation of benefits. In 2017, these two revenue sources accounted for 91.5% of the $996.6 billion collected for the program, with the payroll tax doing most of the heavy lifting. As long as the American public continues to work, the payroll tax and, to a lesser extent, the taxation of benefits ensures that it'll keep making benefit payments to eligible beneficiaries.
In both the 2017 and 2018 annual Trustees reports, 2034 was identified as the year when Social Security's nearly $2.9 trillion in asset reserves would run dry. However, there was a pretty notable shift between these two reports as to when the program would begin running in the red (i.e., expending more than it brings in each year). In 2017, it was estimated that the program's net cash outflow would not begin until 2022. But in the 2018 report, this inflection point was moved up to this year!
Here's why Social Security's estimated net cash outflow date was moved forward by four years
Why the sudden change, you ask? It boils down to two policy changes instituted or projected to be instituted by the Trump administration.
1. The Tax Cuts and Jobs Act will reduce the taxation of benefits
As noted, the Trustees report takes into account a large number of variables when making projections. Among these are policy changes, such as the Tax Cuts and Jobs Act, which was signed into law in December 2017.
The Tax Cuts and Jobs Act permanently lowers the peak marginal corporate income tax rate to 21% from 35%. It also provides a tax cut for many individual taxpayers, with adjustments made to either the ordinary income tax rate or the income range within a tax bracket. These individual tax cuts are set to end on Dec. 31, 2025, which means they'll have a negligible impact on the long-term (75-year) outlook for the program.
However, in the near term, these tax cuts are expected to reduce what the federal government brings in via the taxation of benefits. More specifically, the Tax Cuts and Jobs Act made use of the Chained CPI when indexing the tax bracket income thresholds to inflation rather than the Consumer Price Index for All Urban Workers (CPI-U). The Chained CPI takes into account substitution bias, or the idea that consumers will trade down to similar but less costly goods, whereas the CPI-U does not. Therefore, inflation for the Chained CPI tends to grow at a slower pace than the CPI-U. As a result, less is expected to be collected via the taxation of benefits (at least through 2025, when the tax breaks sunset for individual taxpayers). This revenue reduction played a role in the Trustees moving the program's projected net cash outflow forward.
2. Reduced immigration will lead to less payroll tax revenue
The other factor is the expectation that the Trump administration will introduce policies that'll slow immigration into the country. More specifically, when the Trustees report was released in early June, there was the expectation that the Deferred Action for Childhood Arrivals (DACA) program impacting about 800,000 people would be ended. Of course, federal judges have rejected Trump's attempts to end DACA.
What a lot of people may not realize is that immigration is vital to the short- and long-term success of Social Security. Most legal immigrants tend to be young and therefore willing to work for decades. This means that they'll be paying into the system via the 12.4% payroll tax on earned income, and maybe even through the taxation of benefits, for a long time. If the government reduces legal migration to the U.S., the payroll tax would be expected to decline. And as noted, the payroll tax is responsible for most of the revenue collected for Social Security each year.
Even undocumented workers play a role. In 2010, AARP notes that undocumented workers paid $12 billion into the program via payroll taxes. Since these workers aren't on a path to legal citizenship, they aren't entitled to a traditional retirement benefit and will therefore not get back any of what they pay into the program.
As always, remember that the Trustees report projects what it expects to happen, but what actually happens could be different. But as things stand now, Social Security's imminent problems appear to have crept considerably closer.
The $16,728 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,728 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.
The Motley Fool has a disclosure policy.