Tax Fact 40: Social Security, Not Personal Accounts, Vulnerable to Economic Downturn

One of the more frequent criticisms of George W. Bush’s plan to allow younger workers to invest a portion of their Social Security taxes in Personal Retirement Accounts is that an economic downturn could wipe out people’s accounts, leaving them with nothing for their retirement. While there is always a risk to investing in the stock market, these critics fail to mention how devastating an economic downturn will be to the current Social Security system – a system that is already heading toward bankruptcy.

If nothing is done to reduce this liability, the government will have to raise payroll taxes or cut Social Security benefits.

As most Americans now know, Social Security will begin spending more on benefits than it collects in taxes in just fifteen years, and will continue to run cash deficits as far as the eye can see. According to Social Security actuaries, under moderate economic conditions, these cumulative cash deficits will total $21.6 trillion by 2075 – six times the current national debt.

If nothing is done to reduce this liability, the government will have to raise payroll taxes by 36 percent (to 16.8 percent from 12.4 percent), or borrow more than $11 trillion just to keep the system afloat until 2037, when the trust fund is expected to run out of IOUs. If politicians decide not to hike taxes or increase the national debt, they will have to cut Social Security benefits by at least 26 percent to lower the system’s costs to match its revenues.

But that’s the good news. The bad news is that an economic downturn would make these figures look trivial. Under what Social Security actuaries call the “High-Cost” scenario (where economic growth slows by 30 percent while inflation rises by one-third and unemployment rises 18 percent), the system will begin running cash deficits by 2010 and the trust fund will run out of IOUs by 2025. As the chart shows, through 2075, the system would face a total cash shortfall of $29.5 trillion, 37 percent larger than the mid-range estimate.

To cover these shortfalls, the government would eventually have to double the payroll tax or boost income taxes by nearly 30 percent. Otherwise, Social Security benefits would have to be cut in half.

While some may think that the nation can “grow” its way out of the problem, Social Security’s actuaries estimate that even under more robust economic assumptions, the system faces a total cash shortfall of $7.6 trillion – twice today’s national debt.