Social Security's importance to retirees can't be overstated. According to the Social Security Administration, approximately 62% of existing retirees lean on the program to account for at least half of their monthly income, with a third reliant on Social Security for essentially all of their income. In other words, Social Security is more than just a monthly check most workers will receive during retirement. It's actually a means to build a financial foundation for tens of millions of aged beneficiaries.
Then again, Social Security is also facing what could be described as its biggest challenge ever.
The Social Security Administration's newest annual report spotlights three pervasive issues
According to the latest Board of Trustees report, released in June, the program is set to expend more than it generates in income for the first time in 36 years in 2018. A number of ongoing demographic changes are expected to exacerbate this net cash outflow, eventually leading to the depletion of its nearly $2.9 trillion in asset reserves by 2034. When this happens, and assuming the federal government doesn't find a new way to generate revenue for the program, a benefits cut of up to 21% may be needed to sustain payouts through the year 2092. Not exactly a heartening forecast given how many seniors rely on Social Security as a primary income source.
But it's the release of the "Fast Facts & Figures 2018" report from the Social Security Administration (SSA) last week that really puts the program's issues into perspective. In particular, the report highlights three trends that are at the heart of Social Security's problems.
1. A declining ratio of workers to beneficiaries
Through no fault of their own, baby boomers are certainly part of the problem. Social Security relies on relatively predictable fertility trends to ensure that enough new workers are entering the labor force as older workers retire and move out of the workforce. These new workers are leaned on to generate payroll tax revenue that can be disbursed out to eligible beneficiaries.
Following the end of World War II, fertility rates in the U.S. spiked higher, leading to a surge of births between 1946 and 1964 that became known as the "boomer generation." Unfortunately, the U.S. fertility rate as of September 2017 (1.77 lifetime births per woman) is the lowest it's been since 1976. This suggests that there are fewer workers to enter the labor force relative to the number of boomers who'll be stepping aside.
As you'll note in the chart above, provided in the "Fast Facts & Figures" report, the worker-to-beneficiary ratio has been on a pretty steady decline for a decade, and will continue to slide until about 2035. That's a decline from 2.8 workers to 1 beneficiary in 2017 to 2.2-to-1 by 2035. This shift in fertility trends, combined with the retirement of boomers, is creating a lot of long-term problems for Social Security.
2. A rising average age of retired workers
Though this next point is considerably more subtle than the shift we're witnessing in the worker-to-beneficiary ratio, it's nevertheless playing a role in pressuring Social Security. Namely, we're talking about increased longevity for Social Security beneficiaries.
According to the "Fast Facts & Figures" report, the average age of retired-worker beneficiaries has increased from 72.4 years in 1960 to 73.8 years in 2017. Though that might seem relatively negligible, additional data from the SSA demonstrates that the percentage of the population reaching age 65 has ballooned in recent decades. And, as a reminder, retired-worker benefits can begin at age 62, or any point thereafter.
A now dated look at Social Security life expectancy data provided by the SSA shows that just over 65% of the population was expected to survive between ages 21 and 65 in 1960. By 1990, this had increased to around 78% of the population. In nominal terms, the number of Americans aged 65 and older ballooned from 9 million in 1940, the year Social Security began making retired-worker payouts, to almost 35 million by 2000. As the number of people reaching the qualifying age for benefits expands, and life expectancies rise modestly, the pressure continues to build on Social Security.
3. A declining percentage of taxable earnings
Arguably one of the biggest problems highlighted by the SSA's newest report is the percentage of earnings in covered employment that are being subjected to the 12.4% payroll tax. In 1937, when Social Security first began collecting tax on earned income, 92% of covered earnings were subject to the payroll tax. As of 2017, only 83% of covered earnings were taxable.
The main reason for this decline is growing income inequality. Wage growth has predominantly been confined to the well-to-do, allowing their earned income (wage income, plus interest and dividends) to grow at a much faster rate than the National Average Wage Index, which dictates the maximum taxable earnings cap. Last year, just 6% of the 174 million covered workers had earnings above the payroll tax earnings cap of $127,200 (it's $128,400 in 2018). Yet, 17% of aggregate covered earnings from this small percentage of workers completely escaped being hit by the 12.4% payroll tax. That's an estimated $1.2 trillion in earnings escaping taxation, and it's a big problem!
This chart (and data) is a big reason why Democrats on Capitol Hill have pushed to raise or eliminate the maximum taxable earnings cap. Eliminating the cap and requiring that all earned income be subject to the payroll tax is believed to be a cure-all for Social Security's projected cash shortfall through the year 2092. Of course, getting Congress to agree on a payroll tax increase for the rich is easier said than done.
Long story short, Social Security has plenty of issues to contend with, and the SSA's latest report highlights them in plain-as-day fashion.
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