Note: This blog post summarizes a recent issue brief from the Bipartisan Policy Center. That brief, in turn, updates and refines the analysis of an earlier blog post we wrote on COVID-19’s effects on the trust funds.
Even before the COVID-19 pandemic, Social Security’s finances were unsustainable. For years, demographic and economic trends—especially an aging population—have been raising the program’s costs and depressing its revenue. As Baby Boomers are set to retire, this financial challenge was expected to grow more dire with each passing year.
Then the pandemic hit. And with it came a severe recession that will exact a further toll on Social Security’s finances. But how seriously will the current recession affect the program? How much sooner will reserves in its two trust funds become depleted? The answers to those questions are particularly important because they may ultimately drive the politics around addressing the program’s finances.
Social Security has a retirement program (Old-Age and Survivor Insurance, or OASI) and a disability program (Disability Insurance, or DI), each with its own trust fund. A recession damages the finances of both.
Most of the money Social Security pays out in benefits comes from payroll taxes. A laid-off worker doesn’t pay payroll taxes, nor does the employer share of the former worker’s payroll taxes get paid. Since February, the United States has, on net, lost 10.7 million jobs. That means 10.7 million fewer workers paying into Social Security. Even among workers who have kept their jobs, many have faced cuts in hours or wages, and a slack labor market will slow wage growth, further depressing payroll tax revenue.
Social Security has two other, smaller revenue sources, which are also threatened by a recession. Beneficiaries pay taxes on their benefits if their income exceeds certain thresholds. A deep recession results in fewer beneficiaries meeting these thresholds, meaning their benefits won’t be taxed. Finally, the trust funds hold U.S. Treasury securities that earn interest. The Federal Reserve generally responds to recessions (as it has with this one) by cutting interest rates, which will lower the yields on those bonds. Because these effects reduce revenue flowing into the trust funds, they make the trust funds smaller than otherwise, further reducing their interest income.
Recessions also raise Social Security’s costs. When the labor market is weak, more people claim disability insurance. Meanwhile, a wave of laid-off older workers may be forced to retire—and claim benefits—earlier than they had planned, raising costs to the program in the short term.
Recent history shows how dramatically a recession’s combination of lower revenue and higher costs can accelerate the depletion of Social Security’s trust fund reserves. At the start of 2008—before it was clear that the United States had plunged into a recession—Social Security’s Trustees projected that the combined reserves of the retirement and disability (OASDI) trust funds would be depleted in 2041. In 2012, after several years of a dismal labor market and sluggish economic growth, that projected date had moved up to 2033.
The current recession will likewise cause trust fund reserves to be depleted sooner than anticipated. How much sooner will depend on the recession’s depth and duration, as well as the rate of post-recession economic growth.
Rather than trying to predict the future, we simulate four possible versions of the current recession, ranging from a catastrophic and protracted downturn to a mild and short slump. These stress tests reveal how sensitive Social Security’s finances are to recessions of varying magnitudes. They incorporate lost revenue; more claims of retirement and disability insurance in the coming years; and—unique to this recession—the tragic deaths of older Americans from COVID-19, which will leave fewer OASI beneficiaries and therefore lower program costs.
Table 1 shows when reserves are depleted in each scenario.
Several findings leap out from Table 1. First, even the mildest recession we model would accelerate the depletion of both trust funds—and the combined fund—by at least one year. Second, a wide range of depletion dates is possible. These two takeaways combine into one primary conclusion: The current recession will accelerate depletion of the trust funds, but it is unclear by how much.
What drives faster depletion of the trust funds: lower revenue or greater costs?
Figure 1 takes each aspect of our “pessimistic” recession model and shows the total effect it would have on OASDI’s trust fund over the next 10 years.
As Figure 1 shows, this recession will overwhelmingly affect Social Security by reducing its revenue. How much sooner the trust funds will be depleted therefore hinges on how much and how long payroll tax revenue is held down. This effect, in turn, will depend on the depth and persistence of the recession’s toll on the labor market.
Despite this uncertainty, all our simulations clearly show that the DI trust fund is particularly vulnerable to economic fluctuations. Even our mildest scenarios—which barely speed up depletion of OASI reserves—cause DI reserves to be depleted more than 10 years earlier than Social Security’s Trustees expected before the pandemic. DI is so sensitive to economic changes because its trust fund reserves are small relative to both its revenue and costs. Thus, DI can withstand far fewer years of replacing lost revenue with reserves from its trust fund.
To give concrete intuition, our “pessimistic” scenario is equivalent in magnitude to a repeat of the Great Recession. If that possibility materializes, then the DI trust fund will be depleted just a few years from now—more than 40 years sooner than its trustees had expected before the pandemic.
If reserves in a trust fund were depleted, that program—OASI or DI—could only pay benefits using the revenue it receives each year, which would not be enough to pay all promised benefits. In most of our simulated recessions, depletion of the OASI trust fund would trigger a roughly 25% cut in retirement benefits, while DI reserve depletion would force disability benefits to be cut by around 10%.
The potentially imminent DI financing crunch could have ramifications that extend beyond its beneficiaries. If DI reserves near depletion, it may force Congress to finally confront overdue reforms to the entire program. The last time the DI trust fund was careening toward depletion in 2015, Congress extended its life by transferring revenue from the retirement program to DI. That solution was possible because OASI’s trust fund was projected to last for two more decades at the time, allowing it to forgo revenue without creating a crisis. Such a lifeline for DI would be politically trickier in our simulations: In scenarios where DI reserves are depleted first, OASI’s reserve depletion date looms just a few years later. Congress would find it hard to rescue DI by transferring revenue from an OASI program also on the verge of a crisis.
Once again, the bottom line from our results is clear: The pandemic and recession will cause reserves in both Social Security trust funds to be depleted sooner. But we want to avoid giving the impression that policymakers can wait to act until the crisis of trust fund depletion is imminent. The closer these dates draw—particularly for OASI—the more drastic and unpalatable any solution that maintains the traditional financing structure of the program will have to be: Tax increases will be sharper, benefit cuts will be more severe, and the cohorts of workers who bear these changes will have less time to plan their finances accordingly.
Indeed, if policymakers fail to address Social Security’s financial imbalance soon, they will be left with only drastic solutions or financing a portion of promised retirement benefits through general revenues—turning Social Security from a self-financing insurance program into a perennial drain on resources that are sorely needed for other priorities. Ultimately, the date that matters is not reserve depletion in 2028 or 2030 or 2034, but today—and whether political leaders will step forward with the wisdom and courage to put Social Security on a sustainable path for generations to come.
Download the issue brief