Social Security in 2023: Why It's in Trouble and How to Fix It

Social Security, the largest retirement system in the United States, is facing serious financial problems that require immediate attention. With over 57 million people relying on Old Age and Survivor benefits, it plays a crucial role in keeping U.S. seniors out of poverty. However, without necessary changes, the Trust Fund will be depleted within the next decade, resulting in automatic benefit cuts that will impact all recipients. This article explores the reasons behind Social Security's financial challenges and discusses potential options for fixing the system, including benefit cuts, tax increases, and pre-funding solutions.

Why is Social Security necessary?

As the largest retirement system in the United States, Old Age and Survivor benefits play a major role in keeping most U.S. seniors out of poverty. Over 57 million people receive benefits from the OASI Trust Fund. For approximately 40% of eligible recipients, Social Security benefits account for 50% or more of their total income. Benefits under the program are “earned” through lifetime payment of wage related taxes; once “earned”, benefits are payable based on a fixed formula and are not conditioned on other criteria. Social Security is broadly supported by the public and by most politicians.

What will happen if Social Security doesn't change?

Without any changes to the existing program, Trust Fund dollars will be totally depleted in about 10 years (maybe less). When that happens (absent legislative changes) benefit amounts will automatically be cut; at first by about 20% with cuts growing over time, approaching 30%. All benefits would be reduced proportionately.

Why is Social Security facing serious financial problems?

The largest contributors to the financial problems are demographic in nature:

A. People are living longer; even though modest increases in the full retirement age have been implemented, the life expectancy of current retirees is still significantly longer than those who retired back in the earlier years of the program. In 1940 when benefit payments first began, life expectancy of a 65-year-old was 12.7 years; in 1983 when legislation was passed to increase the full retirement age to 67 the life expectancy of a 65-year-old was 16.5 years; in 2020 the life expectancy of a 67-year-old is 18.6 years.

B. People are having fewer children, this means fewer than expected workers entering the work force.

C. Net Immigration inflow to the workforce has also declined. The combination of these three factors has led to a dramatic reduction in the ratio of current contributing workers to retirees from over 5 in the early years to less than 3 today and projected to go lower in the years to come. As this ratio declines, the current tax/benefit relationship cannot be sustained.

From its inception, Social Security was designed to be primarily pay-as-you-go funding, with no intent to become fully funded to cover accumulating benefit liabilities. Modest accumulations occurred in the early years of the program when there were many contributing workers, and relatively few beneficiaries. Trust Fund investment earnings have not provided meaningful support for plan benefits; primarily because the accumulations were modest; and secondarily because, by law, funds can only be invested in government securities which historically have provided lower returns than other investments (and which have produced artificially low returns for the last 15 years). As the demographics have changed, as discussed above, the modest amounts in the Trust Funds are now being rapidly depleted.

How can Social Security be fixed?

If the Social Security system as we now know it is to be fixed, the solution must come from tax increases, benefit cuts, or some combination thereof. Possible changes in each category which have been proposed are discussed below:

Benefit cuts:

Some proposals have been made to further increase the program’s full retirement age. These proposals argue that a gradual move to higher ages could be accomplished without serious disruption for most workers and would mitigate both the higher number of retirees as wells as the reducing number of workers.

Another significant benefit change which has been floated is the adoption of a “means test” or other mechanism which would reduce or eliminate benefits for the wealthier segment of the retired population. Such a change would significantly modify the “earned” nature of the program.

Tax increases:

The most common proposal would be to raise or even eliminate the payroll wage base cap (currently $162,000). Complete elimination of the cap would reduce the projected funding shortfall by 70% or more.

Other proposals suggest that taxes from non-wage related sources could be earmarked for Social Security.  These might include taxes on investment income, corporate earnings, or even inheritance taxes.  Incorporation of any or all these types of taxes would materially change the current relationship between wage-based tax revenues and future benefit entitlements.

While not currently in any formal proposal, the 6.2% payroll tax rate could be increased across the board. This seems unlikely to have much popular appeal as the FICA tax is already the highest tax paid by a large segment of the US working population.  

Pre-Funding/Investment Returns:

A proposal for a "Sovereign Wealth Fund" has been included in at least one bi-partisan proposal for a partial solution to the Social Security dilemma. While attaining some level of pre-funding and improvement of investment returns within the system seem to be worthwhile goals, the actual implementation of such a plan raises several serious questions: 

1. Where does the seed money come from?
2. What impact would this move have on the overall Federal Budget?
3. If enough funds are deposited to make a significant difference to the Social Security funding, how would the investment of those funds in the market affect market prices and other market activity?

Conclusion

In conclusion, the future of Social Security hangs in the balance, necessitating urgent action to address its financial challenges. Demographic shifts, with people living longer and having fewer children, have strained the system's ability to maintain a sustainable ratio of workers to retirees. To secure the future of Social Security, a combination of solutions is likely required, including potential benefit cuts, tax increases, and exploring alternative funding mechanisms such as pre-funding and improved investment returns. Achieving a balanced approach that preserves the program's fundamental purpose while ensuring its long-term viability is crucial. By making informed decisions and implementing necessary reforms, we can strive to safeguard the economic well-being of current and future generations of retirees.