An economics lesson in Social Security

We all know Social Security has some funding issues. In its most recent annual report, the trustees of Social Security projected the trust fund would be depleted by 2034. If there are no adjustments in funding, the program will only have enough revenue from current workers to pay 77 percent of promised benefits. That is a 23 percent reduction in retirement benefits for everyone who should expect to be collecting Social Security 17 years from now. This is when today’s 50-year-olds are expecting to retiree. I’m not far behind those 50-year-olds, so this concerns me.

What is wrong with the system that is leading to this issue?

First, it should be pointed out that Social Security is not like an IRA or other retirement investment where you make deposits, earn returns, and then draw on the total once you retire. Instead, Social Security, so it could support retirees from the day it became law in 1935, takes contributions from workers and, from those contributions, distributes benefits. Over the course of its history, Social Security collections have far exceeded payments. As a result, the trust currently holds a total of $2.85 trillion. Sounds like a lot of money. However, the trustees project that Social Security will begin drawing down on that amount in 2022, and by 2034 the trust will be depleted.

What is causing this change?

Regarding the funding of the program: first, the number of workers funding the system for each retiree collecting has decreased over time. This comes from a few factors. One is the decline in the birth rate from nearly 3.7 births per woman in the late 1950s to almost half that now (1.9).

A surprising contributor to the funding issue is that the participation in the labor force by “prime age men” (ages 25 to 54) has decreased from 98 percent in 1954 to 88 percent today.  This fact alone is worthy of another discussion.

Another contributor to the funding issues is the percentage of national income subject to Social Security withholdings. Only individual earnings up to $127,200 are eligible for withholding. Any earnings above that amount are free from Social Security taxes.

While the percentage of the population earning above the Social Security threshold has not changed much over the years, around 6 percent has changed, as that small slice of the pie has increasingly been earning a greater share of the overall national income. The percentage of national income subject to Social Security withholdings reached its maximum in 1982 and 1983 at 90 percent. That number has dropped to approximately 80 percent today, reducing the overall national earnings supporting the Social Security system.

On the other side of the equation – the withdrawal side – we are living longer, so, a higher percentage of people are reaching retirement age and, once there, they are collect benefits for more time.

It’s clear that the balance of money going into Social Security and money being pulled needs to be equalized; despite the years of running a surplus, the trust fund is insufficient to cover future retirees.

Regarding contributions, a focus can be made on increasing the number of people putting into the system for each individual receiving benefits. This can come in the form of incentivizing increased family sizes (this approach hasn’t seemed to work), increasing immigration, or legalizing those who already are working here so they pay into the system (immigrants also have birth-rates higher than non-immigrants, which makes the future system more sustainable), and increase labor force participation of prime age males. The upper limit of earnings subject to Social Security witholdings could be increased beyond the current level or the rate of withholdings could be increased.  

On the withdrawal side, we could act as mentioned earlier, increasing the age necessary to withdraw from the system. A reduction in benefits would also help balance the equation. We could also lower the threshold for earnings before Social Security begins to be hit XX TAXED XX, set at $41,880 in 2016.

Additionally, affecting both sides of the equation, the age for collecting Social Security could be pushed higher. This would both keep people in the work force longer, increasing the amount they pay into the system, and reducing the years they are pulling money out of the system.