I previously discussed the future housing needs of the elderly. Those needs coincide with an anticipated ensuing shortfall of Social Security benefits that is only six years away.
For decades, Social Security has been the so-called “third rail” of politics. The term analogizes the electrocution experienced when touching the third rail that powers subway trains. When politicians consider making difficult decisions about Social Security, their careers are subjected to significant political shock. But now that Social Security subway train is about to stop in between stations, and to restart it, politicians must step on that third rail.
As most people know, Social Security was established in the 1930s to provide a safety net for retirees. Back then the average life expectancies were lower than today. For example, in 1940, a 65-year-old man lived an average of 13 years. Today a 65-year-old man is expected to live an average of 19 years while the life expectancy of a 65-year-old woman is 23 years. While this is great news for retired Americans, from an actuarial perspective, it is catastrophic for the Social Security program.
Another aspect of increased longevity is that wealthier people, who tend to receive higher Social Security benefits than low-income individuals, generally also live longer. That means that higher-income people receive more benefits than lower-income people because their benefits are higher and they receive benefits for longer periods of time. This is not necessarily unfair because those earning higher income paid more Social Security taxes when they were working and the amount of Social Security payments one receives is based, in part, on what that person paid in Social Security tax.
Since the mid-1960s, politicians have seen the Social Security fund as a special piggy bank. In order to pay for an unpopular war, instead of raising taxes, the Social Security Fund was used to subsidize the war and subsequent federal spending. The Social Security Fund has invested solely in U.S. Treasury obligations that pay a return substantially less than what other retirement funds earn. Sixty years of low-investment returns substantially reduced the funds available to future Social Security recipients.
In the 1970s, Baby Boomers increased the size of the Social Security wage base, so Congress decided to win the political support of elderly Social Security recipients by indexing their payments for inflation. In the 1990s, part of that was clawed back by adjusting the inflation indexes so that they understated inflation.
In the 1980s, Social Security benefits became taxable income for higher-income individuals. The income taxes paid on those benefits were transferred to the Social Security Fund as a back-door way of reducing the benefits for higher income Social Security recipients.
Today, the Baby Boomers are retiring in large numbers, but the Social Security Fund did not earn a sufficient return to pay for their promised benefits. Based on current government spending levels, the day of reckoning is expected to be 2032 when the Social Security Fund is expected to lack the funds necessary to make all of the promised payments.
This insolvency of the system automatically triggers a 22% reduction in Social Security benefits for all recipients. About 20% of the U.S. population (63 million Americans) will be affected.
According to information published by the Social Security Administration, Social Security benefits were designed to supplement retirement earnings by providing about 40% of retirement income. Ostensibly, a 22% benefit reduction would reduce retirement income by only ~9%. However, according to the Federal Reserve’s Survey of Consumer Finances, 54% of American households have no dedicated retirement savings. Therefore, for those households, a 22% Social Security benefit cut would reduce their income by a full 22%. Plus, those folks are generally the poorest Americans who are already struggling.
Lower-income people spend all of their income, so reducing their income will have a rippling effect on the economy as gross domestic product is reduced because less is spent by retired people. That will likely affect everyone adversely.
Unfortunately, finding a solution will be increasingly painful as time passes, but to date Congress has merely kicked the can down the road. It turns out that road is a cul-de-sac and we are rapidly approaching its end.
Older people will blame the government for this and may turn to extreme political solutions such as democratic socialism or perhaps something authoritarian to protect their interests. Since older people tend to vote in greater numbers, the political consequences of the third rail will potentially consume American politics in the near future.
Jim de Bree is a Valencia resident.
