Expert: Changing Demographics Force Changes to Social Security

February 17, 2023 By Matt Kelly, mkelly@virginia.edu Matt Kelly, mkelly@virginia.edu

Social Security resurfaces periodically as a political football, as it did recently in discussions of the federal debt limit.

A back-and-forth between President Biden and some Republicans at the State of the Union speech over Social Security – and whether it should be cut or protected – became fodder for a round of news stories, television commentators and opinion columns.

But what exactly is Social Security, and why should students and young workers care?

UVA Today talked with Leora Friedberg, chair of the University of Virginia’s Economics Department, whose research focuses on public economics and labor economics, including Social Security.

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Q. How and why was Social Security created?

A. It was created as a social insurance program during the Great Depression, when a lot of people unexpectedly lost all their savings. It gave people a way to retire; otherwise they might have really struggled. That’s when a lot of our social insurance programs were set up in the U.S.

Q. How has it evolved over the years?

A. It was originally set up to be fully funded, with incoming taxes on worker’s income, called “contributions,” going to be saved for those workers later on. It was set up to pay for itself, but that promise wasn’t kept – and by the way, this occurred around the world, not just in the U.S.

The money was coming in and there weren’t many people who needed it for a long time, so they kept increasing benefits early on, with early cohorts getting more out than they paid in. The money wasn’t saved for the later cohorts, so it shifted from being fully funded to, for the most part, pay as you go, which means the money that comes in from the current workers goes to the retirees.

In 1983, the Trust Fund was set up, and now it is going to run out in about 10 years. The Trust Fund survived for about 50 years with some extra money, especially when the baby boom was still in the workforce. But even within a few years of setting it up, they knew the Trust Fund wasn’t going to last forever. Demographics were against it. When the Trust Fund runs out in 10 years, Social Security won’t be able to pay everything as promised, but it will still be able to pay 75% of what’s promised from incoming taxes.

Therefore, even when the Trust Fund is gone, Social Security won’t disappear. After that, the solutions to the funding problem aren’t a mystery.  Essentially, all of the proposals to improve the finances that Social Security involve either more taxes or less spending.

Q. What kind of changes is it going to take to keep this going?

A. Three-quarters of benefits will be covered by ongoing tax revenue. It would therefore take approximately a 25% benefit cut to put Social Security in balance or a tax increase that’s roughly 20% to increase current taxes. The current tax rate is 12.4% (with half paid by employers and half by employees) and that would increase that to about 13.5%.  

Another option is to increase or remove the earnings cap. If you earn more than about $160,000 a year, you don’t pay taxes on your additional income. That cap exists because benefits are also capped. At lower levels, the more you earn, the more Social Security you get up to that same cap. Eliminating that parallel structure between capped benefits and capped taxes by increasing or eliminating the cap on taxable earnings would also help shore up Social Security.

Q. What should young people just starting out in their careers be concerned about?

A. They should think of Social Security as insurance, a safety net that will still be there when they retire – I really want to emphasize that. It’s not there to give you a return on your saving, like a 401(k) plan does, and it doesn’t involve the same risks that come with that. The insurance function is important: It insures you against things like an early death of your spouse, which entitles you to survivor benefits, or a career-ending disability. To some extent it insures you against having lower career earnings than you expected at the outset of your working life. And, importantly, it insures you against living until you’re, say, 95 and outliving your wealth. So, it’s up to you to plan accordingly and save extra if you want more than just the modest standard of living in retirement that Social Security provides.

Q. What about those in retirement or close to it?

A. Past history suggests that benefit cuts are unlikely. Any changes that are made to the system will affect younger people more. But the longer we wait to address the crisis, the worse it will get, and then state pension crises may be instructive. When states deal with underfunded pensions, the ways that current or near-retirees get hurt is through reduced cost-of-living adjustments, delaying the age of eligibility, and a sneaky way to lower your benefits by averaging over a longer period of earnings.

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Q. What is the current age of eligibility for Social Security?

A. You can claim reduced benefits when you’re 62. At 67, you get what’s officially called 100% of your “full” benefit. It’s actually at age 70 that you get the maximum – about 120% of what is called your full benefit. People should think of that as a sliding scale between 62 and 70. The earlier they claim, the lower their benefits for the rest of their life. Claiming later, they’re giving up some current income, but then get higher benefits for the rest of their life. If you have an average lifespan, you get the equivalent of about a 7% or 8% return for each year you wait.

Q. Who is eligible to receive Social Security?

A. You have to have worked 10 years, so you have 10 years in which you’re paying FICA taxes, then you’re eligible for benefits. Or if you’re married to someone who worked 10 years, then you’re eligible for spousal benefits. And you have to be a citizen or permanent resident of the U.S.

Q. How many workers are contributing into the system versus how many retirees are drawing off it?

A. The current number is around three workers per retiree. In the very early days, it was roughly 20. But the shifting demographics of longer lifespan and declining fertility (and, currently, reduced legal immigration) means that has declined substantially.

Q. What do you see ahead for the system?

A. I think there’ll be a combination of increased revenue going to Social Security – increased taxes –  and some moderate benefit cuts. I think those benefit cuts will tend to protect lower earners and hit higher earners more, preserving the safety net function of Social Security. But no one wants to deal with it now, politically, so I think we will deal with it when we’re facing the end of the trust fund, in 10-odd years.

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Matt Kelly

University News Associate Office of University Communications