Addressing Social Security's $19.8-trillion unfunded liability
While retirees, in general, are looking forward to the highest cost of living adjustment (COLA) in 40 years, one set of retirees will get nothing to cover the cost of inflation over the past year. People born in 1960 will find a lump of coal in their stockings come the new year, putting them about $20,000 less prepared for retirement than every other retiree, present or future.
This troubling disparity underscores an unshakeable dogma on Capitol Hill: Social Security is flawless. As a result of that blind faith, Social Security reform deals less with how to fix the program and more with how we pay for what the program currently does.
The system isn't cheating those born in 1960. This result is just the way the system works. It does not protect retirees from inflation that occurs in the year they turn 61. This isn't a problem. It is an unadvertised feature.
The cause of the feature is "wage-indexing." While that term may sound boring, it actually serves as the autopilot of the program. On one hand, this feature determines what retirees get paid and how much tax a worker might pay. On the other hand, the autopilot from time to time takes on the shape of Wile E. Coyote with his ACME box of high finance.
The autopilot of Social Security dates back nearly half a century. In a perfect world, the indexing process serves two roles. First, it ensures that the historic earnings of workers aren't eroded by inflation. Second, it expands Social Security benefits so that voters do not have to wait for Congress to agree upon how to change the program.
The benefits formula within Social Security translates what you earned in the past into a meaningful number for the year in which someone turns 60 — roughly retirement age. To illustrate, if someone born in 1960 earned $15,878 in 1983, for example, the system thinks the worker earned $52,505 (see the SSA's example for more detail).
According to Andrew Biggs of the American Enterprise Institute, the average benefit delivered by the program grew by 32 percent after inflation since 2000. That means that Social Security has expanded itself by nearly 1.5 percent on average over the past 20 years.
Unfortunately, there is a gap in the inflation protection provided by Social Security. Up to the age of 60, wage-indexing takes care of the changes in prices because employees get raises that generally incorporate inflation. For those 62 and older, the COLA ensures that buying power remains constant. The year in which a worker turns 61 is, shall we say, "a gap year."
Separately, wage-indexing is also part of the ongoing questions surrounding the program's long-term financial stability. Most Americans understand that the growth of revenue going into Social Security is rising more slowly than the growth of expenses coming out of Social Security.
The part that they generally miss is that some of that instability is the unintended consequence of wage-indexing. In the existing system, the program's revenue grows based on what happens to paychecks up to a cap — currently $142,800 (soon to be $147,000). Wage-indexing, however, grows expense based on every dollar earned by workers.
The people who came up with this process did not envision wage inequality or its implication for Social Security. When wages earned above the cap grow more rapidly, the program expands benefits but doesn't generate any offsetting revenue to pay the bills.
To illustrate the problem, ordinary workers did pretty well in 2020, earning 1.5 percent more in wages than they did in 2019. People who earn more than the cap, on the other hand, absolutely raked bank. Combined, the system made the benefit formula 2.83 percent more generous because the expansion of benefits is based on wage growth as a whole.
If wage growth is unequal over one year, it wouldn't be a problem. If it is a 40-year trend, the program will expand benefits faster than its ability to pay them. This is part of the problem with Social Security that Congress should fix rather than pay for.
These problems are not insurmountable, but progress hinges on one thing: someone on Capitol Hill would have to acknowledge that a program with a financial gap of $19.8 trillion is not flawless.
Brenton Smith is a policy adviser at The Heartland Institute, with work appearing in nationally recognized publications including Barron's, Forbes, MarketWatch, The Hill, USA today, and more.
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