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Could Trump prove Social Security forecasters wrong?

The Motley Fool logo The Motley Fool 8/9/2018 Sean Williams

To say that the presidency of Donald Trump has been a bit unorthodox is probably an understatement. Then again, Trump is a businessman by nature and has no prior military or political background -- which is a first for an elected president.

But while "The Donald" hasn't exactly approached issues in a similar fashion to his predecessors, he's been very clear about one thing: Social Security is off-limits.

Social Security's judgment day is approaching 

As you may be aware, America's most important social program is nearing trouble. The 2018 report from the Social Security Board of Trustees has forecast that the program will begin paying out more in benefits this year than it'll collect in revenue.

Even though we're only talking about a net cash outflow of $1.7 billion, which is nominal next to the $2.9 trillion in asset reserves, this outflow is expected to increase with each passing year after 2019. By 2034, Social Security's excess cash is projected to be completely depleted, leading to what could be a 21% across-the-board reduction in benefits for existing and future beneficiaries. This cut in benefits should preserve payouts through the year 2092 without the need for any further cuts, but would nonetheless be a major blow to the 62% of aged workers currently relying on the program for at least half of their monthly income.

Whereas the American public and most members of Congress would prefer solutions that directly address Social Security's issues, President Trump has touted a more indirect approach. Rather than proposing amendments to the existing program, Trump has long believed that growing the U.S. economy is the best way to address Social Security's funding shortfall.

How would this work, you ask? Well, first it helps to understand how Social Security generates money. Currently, there are three funding mechanisms:

  1. A 12.4% payroll tax on earned income (up to $128,400, as of 2018)
  2. Interest income earned on its asset reserves
  3. The taxation of Social Security benefits

By 2034, when the program's asset reserves are exhausted, interest income will presumably disappear, leaving only the payroll tax and the taxation of benefits as its ongoing sources of income. Of these, the payroll tax is the giant. Last year, it was responsible for $873.6 billion of the $996.6 billion collected.

Related video: Expert Says Social Security Will Change In Coming Years (provided by CBS Minnesota)

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Could Trump prove Social Security's trustees wrong?

Where Trump's thesis comes into play would be primarily on the payroll tax side of the equation. If he could introduce policies that would stimulate the U.S. economy, thereby improving aggregate wages and income, as well as lifting productivity, then we'd likely see a corresponding increase in the amount of payroll taxes that are collected.

Although the Trustees have included Trump's spearheaded tax reform law, the Tax Cuts and Jobs Act, into its 2018 projections, it may be possible for this law to prove the Trustees' projections wrong in the near term.

You see, recently released data showed that U.S. gross domestic product (GDP) grew by 4.1% during the second quarter, representing the fastest pace of growth since 2014. Further, even though wage growth has been modest when looked at over the intermediate term, it grew to its fastest pace in nine years during the first quarter. This was primarily a result of businesses basking in substantially lower corporate income tax rates, with some of this retained extra capital being passed along to employees in the form of bonuses and higher wages.

Getting to the point, better-than-expected GDP growth coupled with modest improvements in wages could lead to an upside surprise in terms of payroll tax collection in 2018. After all, the Trustees only forecast a $4.5 billion increase in aggregate income relative to last year ($1,001.1 billion in 2018 vs. $996.6 billion in 2017), based on the intermediate-cost model.

Yes, the newly adjusted federal tax brackets could adversely impact income from the taxation of benefits, but it's not out of the question that the projected $1.7 billion net cash outflow in 2018, or $0.2 billion estimated outflow in 2019, could actually turn into an inflow as a result of higher-than-expected payroll tax collection, pushing Social Security's inflection point out further.

Keep the bigger picture in mind 

The important thing to remember here is that even if Donald Trump's indirect approach of tackling Social Security's problems works initially, it's incredibly unlikely that it'll work for any extended period of time.

According to the Trustees, the program is facing a $13.2 trillion cash shortfall between 2034 and 2092. The only ways to erase this deficit would be by raising additional revenue, cutting long-term expenditures, or doing some combination of the two.

Creating $13.2 trillion in added revenue just from economic growth and wage increases probably isn't possible, given that the U.S. economy has natural peaks and troughs. Even though we're in the midst of one of our longest expansionary cycles in some time, a recession will eventually hit the U.S. economy, and any chance of growing payroll tax revenue at an above-average rate will falter. It's not a matter of "if," but "when."

In all likelihood, direct solutions that make amendments to the Social Security program will be needed to address its issues. This might mean lifting or eliminating the maximum earnings cap associated with the payroll tax and requiring the wealthy to pay more, as Democrats have pushed for, or it could take the shape of an increased full retirement age, which would reduce long-term program expenditures. This latter idea is a cornerstone of the Republicans' plan.

No matter what the solution is, indirectly trying to fix Social Security looks to be nothing more than a Band-Aid on a gaping wound.

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