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Here's what 'cutting' Social Security benefits actually means

The Motley Fool logo The Motley Fool 5 days ago Sean Williams

a close up of a newspaper: Two Social Security cards, and two one hundred dollar bills, lying atop a payout card. © Getty Images Two Social Security cards, and two one hundred dollar bills, lying atop a payout card. As you're probably aware, our nation's most treasured social program, Social Security, is in some pretty big trouble. Despite making benefit payments for eight decades and keeping more than 22 million people out of poverty each month, the program is facing an estimated $13.9 trillion cash shortfall between 2035 and 2093, with 2035 being the year that the program's nearly $2.9 trillion in asset reserves is expected to be completely exhausted.

This means that it's up to our elected officials in Congress to fix this mess.

However, Democrats and Republicans have approached resolving Social Security's imminent cash crisis from opposite ends of the spectrum. Generally speaking, the public views Democrats as wanting to expand Social Security, while chastising the GOP for wanting to cut Social Security benefits. But it's not this cut-and-dried. Expanding benefits doesn't mean that everyone suddenly makes more each month, and "cutting Social Security benefits" doesn't mean that everyone winds up with a smaller benefit check.

To better understand this process, let's take a closer look at what is actually meant by "cutting Social Security benefits," as defined by most Republican proposals to improve Social Security's long-term solvency.

Related video: Social Security funding, explained (provided by USA Today)

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Direct Social Security cuts aren't very popular, and we're unlikely to see them implemented

There are two ways to look at cutting Social Security benefits -- i.e., reducing long-term program expenditures. These methods are: direct cuts and indirect cuts.

The idea of directly cutting Social Security payouts tends to be extremely unpopular among the public. This would involve reducing benefits across the board when the program runs out of its asset reserves in 2035. Back in 2014, the Washington Post created an informal online poll that allowed users to pick from one dozen "fixes" for Social Security, half of which focused on adding new revenue and half of which cut long-term expenditures. Users were free to choose as many of the solutions as they wanted, as long as they could honestly say they stood behind them. Of the 12 choices, doing nothing and simply cutting benefits when the program ran out of cash in roughly two decades' time finished dead last in the polling, with about 2% support.

To be crystal clear, neither Democrats nor Republicans favor this approach.

However, there is another form of direct benefit cuts that has gained some interest on Capitol Hill from both parties: means testing.

Means testing is the idea of partially reducing or eliminating benefits once an individual or couple filing jointly crosses above preset income thresholds. In other words, if you're already making a lot of money, even in retirement, then you probably aren't reliant on your Social Security benefit to make ends meet. Means testing would resolve this issue by reducing or eliminating payouts to upper-income seniors and couples. Both President Trump and Democratic presidential front-runner Joe Biden have hinted at the idea of means testing in the past, although it's only gained lukewarm interest on Capitol Hill.

a close up of text on a white background: The words, Time to Retire, written and circled on a calendar. © Getty Images The words, Time to Retire, written and circled on a calendar.

Here's what "cutting benefits" really entails

The other option is indirect cuts, which is what most Republican proposals actually entail.

An indirect cut doesn't mean taking the scissors to what Americans are receiving via Social Security. Rather, reductions to program outlays would be realized over long periods of time, with two proposals doing the heavy lifting.

The first core GOP proposal involves gradually raising the full retirement age over time. Your full retirement age is the age at which you become eligible to receive 100% of your monthly payout, as determined by your birth year. For everyone born in or after 1960, your full retirement age is 67. Republicans would prefer to see this figure gradually increased to as high as age 70.

Why? Well, since 1940, the average life expectancy at birth in the U.S. has risen by more than a decade, yet the full retirement age will have gone up by just two years, through 2022. That means beneficiaries are netting a payout for a longer period of time, which is contributing to Social Security's woes. By gradually raising the full retirement age, future generations of workers, such as millennials, would need to wait longer to receive their full payout, or accept a steeper monthly reduction if claiming early. The point being that no matter which path future generations choose, their lifetime benefits collected (not necessarily their monthly payout) would be reduced. You should note that raising the full retirement age has no impact on current retirees and those folks who are near the initial age of claiming eligibility (62).

The second part of the GOP plan to reduce program outlays involves switching Social Security's inflationary tether from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to the Chained CPI.

The Chained CPI takes into account an idea known as substitution bias. If, for example, you're walking down the meat aisle in the supermarket and notice that ground beef prices have gone up a lot, you might choose to buy chicken or pork instead. This is substitution bias in action. While it's a real-world consumer action, the inclusion of substitution bias tends to underreport the inflation that consumers are facing. In other words, using the Chained CPI would almost certainly lead to smaller annual cost-of-living adjustments (COLA).

Although a smaller COLA would be practically unnoticeable over a year or two, the compounded effect of smaller COLAs -- which impacts all recipients, and not just future generations of workers -- over multiple decades would result in cost savings for Social Security, and an even greater loss of purchasing power for program recipients.

This is what "cutting benefits" is all about. It's not taking the scissors to existing monthly payouts. Rather, it's reducing lifetime benefits of future generations by coercing them to stay in the workforce longer, as well as passing along modestly lower COLAs over time that impact the purchasing power of Social Security dollars.

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