Will Social Security change as spending cuts are considered?

As the new administration explores options to reduce federal government spending, concerns are rising around changes to Social Security. For example, what actions may be considered that could potentially impact Social Security benefits? While there have been discussions around closing offices or reducing the workforce of the Social Security Administration, making structural modifications to Social Security, such as raising the retirement age, are more complicated. For this reason, major changes to Social Security in the near term are unlikely.

Republican lawmakers are currently pursuing tax and spending-related changes through a process known as budget reconciliation. To gain more understanding of the reconciliation, see our recent post, “Tax policy takes center stage: What to watch on Capitol Hill.” This process allows lawmakers to pass legislation in the Senate with a simple majority, avoiding the 60 vote-threshold needed to avoid a filibuster. Even with slim majorities in both chambers of Congress, the Republicans can advance a bill without Democrat votes.

However, Senate procedural rules prevent using the budget reconciliation process to make changes to Social Security. The Congressional Budget Act of 1974, which introduced budget reconciliation, explicitly prevents changes to Social Security unless normal rules are followed. Since it’s probably unlikely that we’ll see a party control at least 60 seats in the Senate, making major changes will require bipartisan support. Latest projections call for the Social Security Trust Fund to be depleted in 2035, causing a roughly 20% reduction in benefits, unless Congress takes action.

Here are some potential policy options to fix Social Security:
 

Additional points to address the challenge

• Currently, employment earnings below $176,100 are subject to the Social Security payroll tax. Some lawmakers have proposed increasing that threshold, exposing more earnings to payroll tax.  One plan would maintain that threshold but also apply payroll taxes on earnings over $250,000. That would mean, based on current limits, a worker’s first $176,100 would be subject to the 6.2% payroll tax and then the payroll tax would apply again on all earnings above $250,000. This would result in a “donut hole” where earnings between $176,100 and $250,000 would not be subject to Social Security payroll tax. Making this adjustment would result in generating significant revenue.
• Originally, the taxable wage base was designed to cover 90% of earnings in the United States. Currently, 83% of earnings are subject to Social Security payroll tax since wages for higher-income taxpayers have grown faster than those of lower-income taxpayers. If policymakers wanted to reach the 90% target now, the taxable wage base would have to increase to roughly $300,000.
• Some proposals call for including all state and local employees as part of the Social Security system. In some states and municipalities, employees are covered by a separate retirement program instead of Social Security (roughly 5% of workers nationwide are not covered by Social Security).

Considerations for retirement planning

The long-term future of Social Security is in the balance. However, even if Congress doesn’t act, beneficiaries are projected to receive roughly 80% of scheduled benefits.¹ There is confusion that the depletion of the trust fund will mean that benefits are completely gone. This is not the case. However, prudent planning must incorporate the risks of a reduced benefit amount in the future, higher taxes, or both.

• Younger investors should factor in potential benefit reductions in Social Security as part of a comprehensive retirement savings and income plan. Look for opportunities to increase savings as early as possible.
• Take a thoughtful approach to claiming Social Security, especially if those benefits are the only source of guaranteed, lifetime income. Avoid making a rash decision to claim Social Security early just because you’ve heard that the trust fund is being exhausted. An eventual plan to address the issue will likely not impact current and near retirees as much as younger workers.