Social Security Insolvency

Published March 22, 2023

Social Security has been long viewed as untouchable in American politics.  An aging population seemingly only further entrenches this.  Yet cuts may be coming if Democrats and Republicans do not act today.

          Social Security’s potential insolvency would trigger benefit cuts.  Here’s how Veronique de Rugy of the Mercatus Center describes it, “Failure to reform, in fact, means benefits will automatically get cut. … [W]hen the Trust Fund runs out of IOUs around 2033, Social Security benefits by law will be cut by about one-fifth.”

          To unpack this, let’s start with the structure of Social Security.  The taxes funding Social Security, primarily the payroll tax, goes into a Trust Fund (technically two funds, but money can be shifted between them), from which benefits are paid.  Any surplus is invested in U.S. Treasury securities.  The program operates on a pay-as-you-go (PAYGO) basis, instead of accumulating assets like a private pension.

          Today benefits slightly exceed tax revenues, so the Fund operates at an annual deficit.  Thanks to earlier surpluses, the Fund has a balance of $2.6 trillion.  The annual deficits are projected to grow over the next decade and insolvency occurs when the balance is zero.  The Social Security system’s trustees project this in 2035, while the Congressional Budget Office predicts 2032.  Which year is correct is immaterial.

          The Antideficiency Act prohibits Federal agencies from spending funds they do not have.  Social Security revenues are projected to be 80 percent of annual benefits at insolvency.  This yields the 20 percent benefit cut.

          Yet the Social Security Act creates a legal entitlement to benefits.  Insolvency will bring these two laws into conflict.  The Congressional Research Service is unsure which law will take precedence.  Warnings of impending cuts presume the Antideficiency Act will rule, so benefit cuts are not written in stone.  Also, Congress could hike the payroll tax to avoid insolvency.

          Why does this matter?  Economist Thomas Sowell says that the first lesson of economics is scarcity, while the first lesson of politics is to deny the first lesson of economics.  Economists, I think, should be clear whether scarcity or rules and procedures force choices on us.

          Rules and procedures drive the feared benefit cuts, not scarcity.  Scarcity means that the current 12.4 percent payroll tax is inadequate; either Social Security taxes must increase, benefits must be cut, or both.

Will Social Security become unaffordable?  Some commentators offer very scary projections, but here’s a straight-forward approach.  Our aging population is lowering the worker to retiree ratio, stressing our PAYGO program.  This ratio exceeded three in the 1990s, currently stands at 2.8, and may eventually fall to two.  Since a 12 percent payroll tax covered annual benefits with three workers per retiree, an 18 percent tax should fund current benefits with two.

Careful calculations suggest a lower rate will suffice.  The Congressional Research Service estimates that a 15.6 percent rate rising eventually to 16.7 percent will fund benefits.  I do not favor any tax increase, but a four-percentage point increase will not cause economic ruin.

Medicare is on weaker ground going forward, but I am only considering Social Security’s sustainability today.

Social Security has problems making it poor public policy.  Most significantly, PAYGO produces an atrocious rate of return compared to true pensions.  According to one estimate, the average participant will get $698,000 in benefits for $698,000 in taxes.  A better public pension plan should enable reform long-term.

Social Security’s funding problem reflects a larger problem facing our nation.  We want more from government than we are willing to pay for in taxes.  This fiscal imbalance produces our ballooning national debt and traces back, I believe, to the partial Reagan Revolution.

President Reagan wanted to cut government, both taxes and spending. Spending cuts proved unattainable but tax cuts remained politically popular, so President Reagan proceeded with tax cuts culminating in the landmark 1986 tax overhaul.  This locked in low taxes which persist today.

To sustain current Social Security benefits or Federal spending, Americans will have to pay more in taxes.  I hope we choose less government and more freedom, but scarcity will force a choice soon.