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The awful truth about expanding Social Security benefits

The Motley Fool logo The Motley Fool 9/18/2018 Sean Williams

In July, more than 62 million people received a Social Security benefit, almost 70% of whom are retired workers the program was designed to protect. Of these aged beneficiaries, the Social Security Administration (SSA) finds that 62% are reliant on their monthly check to account for at least half of their income, with 34% leaning on their payout for virtually all of their income (90% plus). Or, in simpler terms, without the guaranteed monthly benefit that Social Security provides to qualifying retired workers, we'd likely be dealing with a major elderly poverty crisis right now.

But for as pivotal as Social Security has been in forging a foundation for our nation's retirees, many would suggest it's not going far enough. The average retired worker took home only $1,414.73 in July, which works out to less than $17,000 a year. By comparison, the federal poverty level for a single person is $12,140 in 2018. That's not a lot of cushion. Though it's a program the SSA cautions will replace only about 40% of the average worker's wages during retirement, current and future retirees would like to see those benefits expanded. 

Unfortunately, the awful truth is that expanding Social Security benefits just isn't a viable option at the moment.

Social Security is facing a big challenge 

According to the newest Social Security Board of Trustees report, the program is set to hit a major inflection point this year. Beginning in 2018 and continuing every year thereafter, the SSA is projected to expend more than it generates in annual income. Although the program has a healthy amount of excess cash that's been built up over the past 35 years (nearly $2.9 trillion), it's expected to dwindle over the next 16 years. By 2034, Social Security's asset reserves are estimated to be depleted.

Related video: Can Social Security be fixed? (provided by CBS News)

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What happens then? The good news is that payouts continue without interruption. Even without the interest income provided by the program's excess cash, the 12.4% payroll tax and the taxation of benefits ensures that revenue will keep flowing in. Short of Congress changing the way that Social Security is funded, it simply can't go bankrupt.

However, a depleted asset reserve demonstrates that the existing payout schedule isn't sustainable. Per the Trustees, an across-the-board 21% cut to benefits may be necessary by 2034 to sustain payouts through the year 2092. Assuming constant 2018 dollars, this would reduce the average retired worker's payout to just over $13,400 a year, which is dangerously close to the federal poverty level.

Overall, the report suggests that Social Security is facing a cash shortfall of $13.2 trillion between 2034 and 2092.

Here's what it would take to fix Social Security 

Breaking things down, there are essentially three ways to resolve Social Security's long-term (75-year) cash shortfall: raise additional revenue, cut expenditures, or implement some combination of the two. However, if you were to ask the American public, raising additional revenue is by far the most popular choice.

According to the report, the actuarial deficit in 2018 is 2.84%. Very simply, the actuarial deficit represents how much the payroll tax would need to increase today to generate additional revenue and resolve the program's 75-year shortfall, as well as leave Social Security with enough in its asset reserves by 2092 to cover a full year's worth of expenditures.

The payroll tax, which accounted for 87% of income collected last year for Social Security, totals 12.4% of earned income (e.g., wage income, interest, and dividends) up to $128,400 (in 2018). However, it's worth pointing out that most workers don't pay the full 12.4%. If you're self-employed, you do, but if you work for someone else, your employer covers half (6.2%) of your liability. In order to fix Social Security through 2092, the payroll tax would need to increase by 2.84% (284 basis points) today to 15.24%. That's 2.84% more for the self-employed and 1.42% more for employers and employees. Should such an increase be approved by lawmakers on Capitol Hill, the Trustees suggest that no benefit cuts would be needed over the next 75 years.

Here's why increasing benefits isn't reasonable 

However, there's plenty of evidence to suggest that passing along a payroll tax increase isn't as easy as it sounds.

To begin with, lawmakers haven't been able to agree on much when it comes to Social Security. The last major overhaul of the program occurred 35 years ago during the Reagan administration. Today's Congress is highly partisan, with both Democrats and Republicans believing they have the better long-term solution. Thusly, neither party has been willing to find common ground with the opposition.

Perhaps the bigger issue is what it would take to keep benefits steady as they are, let alone expand future benefits.

In 2016, the Voice of the People survey questioned nearly 8,700 people about their willingness to accept a payroll tax hike in order to improve the health of the Social Security program. Some 76% of respondents were in favor of an aggregate 80-basis-point increase to 13.2%. But when questioned about a 140-basis-point (13.8%) or 200-basis-point (14.4%) increase, support among the public fell to 45% and 19%, respectively. Now, keep in mind that a 284-basis-point increase is needed to sustain payouts through 2092, and public support is nowhere to be found for even a 200-basis-point hike. 

But you have to understand that 284 basis points only resolves the 75-year cash shortfall and keeps benefits from being cut. It doesn't expand them. If benefits were to be increased, we'd probably need to see the payroll tax rate increase by 350 basis points to 400 basis points. If a 200-basis-point increase had the support of just 19% of the public, imagine how little favorability there'd be for a 350-basis-point to 400-basis-point hike.

As much as current and future retirees would like to see Social Security's benefits expanded, the chance of that happening anytime soon is virtually zero.

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