While it may come as no surprise, the sooner Congress implements reforms to the Social Security system, the lesser the impact might be on beneficiaries; but the closer it gets to 2034, when the trust fund reserves are estimated to be depleted, the more the options become limited—and potentially more severe. 
That was the critical warning outlined in a new issue brief from the American Academy of Actuaries (AAA). In fact, without reforms ahead of 2034, people already receiving benefits by that depletion year could face an automatic 20% cut in benefits, the paper advises.
“The American Academy of Actuaries’ latest review of Social Security data and projections shows a clear, compelling benefit and public good to Congress engaging the reform process sooner rather than later,” noted Academy Senior Pension Fellow Linda K. Stone. “Acting now to address Social Security’s financial challenges would allow Congress to consider reform options that are more moderate, gradual, and give the American people time to adjust to any needed changes in benefits or taxes.”
Tax Increases vs. Benefit Cuts
According to the brief, one thing that’s different compared to the reforms that occurred in the early 1980s is that Social Security’s projected cash shortfall in 2034 is projected to be three times as large as the last time the trust funds were close to depletion in 1983—at 3.12% of taxable earnings vs. 1%.
Consequently, reforms enacted at or near the trust-fund depletion date could be on the order of increasing the payroll tax rate by 25% or a combination of benefit cuts and tax increases with the same actuarial effect, the paper warns.
If looking just on the tax side, for example, the current 6.2% tax rate would need to be raised to 7.75% for both workers and employers, yielding enough to pay 100% of benefits in 2034. That said, employee and employer payroll tax rates have never been increased by more than 0.5 percentage points of taxable payroll in any one year, the actuaries observe.
Another option would be to eliminate the taxable maximum ($160,200 in 2023) so that all earnings are taxed. While this approach would avoid impacting low-income workers, it could result in a large tax increase on high-income workers (and their employers) and it would cover only 78% of the 2034 shortfall, so additional changes would still be needed.
What’s more, when Congress amended Social Security in the past, benefit reductions were only applied to individuals not yet eligible for benefits, so current recipients did not have their benefits cut, the paper further emphasizes. In addition, Congress has always phased in large benefit reductions, as a large reduction to one cohort, while not affecting the prior cohort, could be seen as unfair. “If Congress wants to continue these two traditions, and avoid a large tax increase in 2034, reform is needed as soon as possible so that the phased-in changes are enough to pay all benefits in 2034,” the Actuaries contend.
In addition to raising the normal retirement age to reflect longer lifespans, other options on the benefits side include reducing the 15% replacement rate at the high end of the benefit formula to 5% over five years. Still, this would cover only 3% of the 2034 shortfall because it only applies at the higher end of the income scale.
A means test could have more impact, as it could fully eliminate benefits for people with incomes or assets over certain thresholds, but such changes would be difficult to enact, the paper observes. Meanwhile, a partial means test does not affect high-income workers as dramatically, but it also does not have much impact, as estimates show that such changes would cover only 5% of the 2034 shortfall.
“Last-minute reforms likely would look very different from the early 1980s, including potentially Congress having to break its traditions of not applying benefit cuts to currently eligible individuals, and of phasing in rather than making abrupt benefit reductions between different cohorts of Social Security beneficiaries, or it could tap general revenues,” Stone noted.
Note that Congress may also be forced to enact tax increases to keep Medicare’s Hospital Insurance Trust Fund from being depleted around 2031, only adding to the impact on beneficiaries, taxpayers and otherwise those saving for retirement.
“The alternative of gradual reform options can address the program’s financial challenges while easing impacts on tens of millions of current and future beneficiaries and the many older Americans who rely on Social Security for half or more of their income,” said Stone.
The full issue brief, which dives even deeper into the tradeoffs between various tax increases and benefits cuts, can be viewed here.
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