How is Social Security running out of money? We keep paying payroll taxes, but Social Security’s retirement program, officially called Old Age, Survivors, and Disability Insurance (OASI), is projected to only be able pay out approximately 77% of benefits starting in 2034.¹ That being said, Social Security distributions have continued to be paid out for the past 40 years and even periodically increased for cost-of-living adjustments.

Why are there expected shortfalls? What can we do? This article provides some background and resources for understanding the shortfall.

To find out more about Social Security retirement funding, two easily usable free resources stand out. The Social Security website has considerable information, including pages on the history of Social Security² and statistics on Social Security funding.³ Another great research point are the Congressional Research Service reports, also known as CRS reports.⁴ Many of the references in this article are from sources found there.

Social Security is funded largely through a payroll tax⁵ and based on an insurance model.⁶ With the insurance model, people pay into the system over the course of their lives and when they are of retirement age, they can collect according to average income over their highest 35 years of pay,⁷ which in turn is related to the amount they have paid in. Roughly speaking, the more someone has contributed, the more they are able to collect per month in their retirement. Excess payroll taxes are put into a trust fund that can loan money to the government and collect interest.

While Social Security pays more to people who have contributed more, it also proportionally rewards people at the bottom of the income scale more than those at the top.⁸ Perhaps coming from the lessons of the Great Depression, the Social Security Act was considered to contribute to the general welfare as evidenced from its title stating, “AN ACT To provide for the general welfare ... .”⁹

In a balance with Social Security’s redistributive aspect, there has always been a cap on the amount of income subject to the payroll tax. The current cap is $160,200; income above that cap is not subject to the payroll tax.¹⁰ Although variable by retirement age, the current maximum benefit distribution for someone who retires at age 70 is $4,555 per month.¹¹

Social Security has a long tradition of periods where it did not have enough money. Although not technically a shortfall, the Social Security Act that passed in 1935 did not collect payroll taxes until 1937 and did not pay out monthly benefits until 1940.¹² That being said, from 1937-40, Social Security did provide a lump sum to people who retired during that period.¹³ Because the Social Security retirement system was scheduled to make payments to elderly people only five years after it passed, it may have needed some time to build up its reserves. As a method of addressing other shortfalls, periodic hikes in the percentage of payroll taxes have been used to fund Social Security. These tax rates have risen from 1% in 1937 to 12.4% (split between employees and employers, including disability insurance along with OASI) in 1990, which is still the current payroll tax percentage.¹⁴ The 1990 rate increase was instituted by the Social Security Amendments of 1983 to address a shortfall.¹⁵ The increase worked quite well until 2010. That year, Social Security funds shifted to a cashflow deficit that has persisted since and is projected to continue under the current tax and distribution scheme.¹⁶

There are several reasons why the Social Security payroll tax has failed to keep up with distributions and, more importantly, is projected to continue to fail to keep up with distributions. Social Security actuarial experts point out that the biggest cause of the sustained shortfall is the continued decreased in birth rate after the baby-boom generation.¹⁷ The average number of children born to a single family has gone from roughly three children down to two children.¹⁸ This reduction in birth rate has resulted in fewer workers supporting each retired person.¹⁹ Another major contributing factor, of course, is the increasing life expectancy in the U.S., which can also lead to an increased number of beneficiaries per worker.²⁰ There are many contributing factors beyond birth rate and death rates, however, including employment rates, productivity gains, and interest rates.²¹ One example of a surprising economic factor contributing to the shortfall is increasing economic inequality.²²

Calculations show a clear prediction of the gap between what payroll taxes bring in and what distributions go out. But there are many solutions to close the gap, such as payroll tax rate hikes, alternative sources of revenue, smaller payments, and increased ages for retirement. The Office of the Chief Actuary has described and analyzed many of them.²³ While no solution will be perfect, planning for the long term can be successful. As discussed, the 1983 Social Security Amendment made adjustments that provided 40 years of solvency and may be adequate for another 10 years. Despite predictions of a Social Security shortfall, history shows there is still time and means to prevent it.