Breaking the Social Security crisis: Are we too late to fix it?

Yogesh Prasad, CFA, CAIA
CEO & Founder of Confluent Asset Management

Social Security is at a crossroads. By 2035, the trust fund that supports millions of Americans could run dry, leaving payroll taxes to cover only 83% of promised benefits. Without action, recipients may face a painful 17% cut. The root issue? An aging population and a shrinking ratio of workers to retirees, now just 3-to-1 and set to decline further.
Past reforms haven’t addressed the system’s long-term challenges, but solutions exist. Adjusting benefit calculations, raising the retirement age, tweaking inflation measures, or lifting the payroll tax cap could restore stability. Meanwhile, countries like Australia, Singapore, Sweden, and Chile have pioneered reforms that balance public support with personal savings, offering valuable lessons.
It’s time to rethink Social Security—ensuring it works not just for today’s retirees but for future generations too.
How Social Security really works: A deep dive into Social Security
Social Security is a cornerstone of retirement planning for millions of Americans, but how does it work? At its core, Social Security is a defined benefit pension system, where retirees receive benefits based on their lifetime earnings. This “pay-as-you-go” structure relies on payroll taxes collected from today’s workers to fund benefits for current retirees, making the system’s health closely tied to workforce contributions.
Payroll taxes apply to wages up to $168,600 in 2024, with a combined rate of 12.4% split between employers and employees. Benefits are calculated progressively, replacing a higher share of income for lower earners compared to higher earners. For instance, the first portion of income is replaced at a 90% rate, while higher income brackets see lower replacement rates, ensuring the system provides greater support to those who need it most.
Retirees can claim full benefits at age 67 (for those born in 1960 or later), with options to take reduced benefits at 62 or increased benefits by delaying until 70. Taxation of benefits adds another layer of progressivity, with lower-income households exempt from taxes on their Social Security income and higher earners taxes those who need it most.
Retirees can claim full benefits at age 67 (for those born in 1960 or later), with options to take reduced benefits at 62 or increased benefits by delaying until 70. Taxation of benefits adds another layer of progressivity, with lower-income households exempt from taxes on their Social Security income and higher earners taxed on up to 85% of their benefits.
While Social Security isn’t explicitly means-tested, its progressive formula ensures that lower earners receive a proportionately larger benefit. It’s a system designed to balance support across income levels—but understanding its mechanics is key to making the most of this vital program.

The Social Security system adjusts its benefit brackets annually to match wage increases, maintaining consistent replacement rates for retirees across income levels. This approach ensures that benefits grow in real terms over time, keeping pace with wage growth. The system projects a 1.14% annual increase in real wages, which translates to higher real benefits for all income groups. For instance, lower-income workers are expected to receive benefits 43% higher in real terms by the end of the century compared to current medium-wage workers. Similarly, medium-wage workers will see benefits 79% higher than current high-wage workers. The system also provides additional benefits for married couples, potentially doubling the amount in cases where both spouses worked and qualified for benefits.

Sources: Social Security and Medicare Boards of Trustees, “The 2024 OASDI Trustees Report”, Table V.C7; Tax Foundation calculations
The Social Security crisis: What’s really at risk for your future?
Social Security faces an impending crisis as the ratio of workers to beneficiaries’ plummets. By 2033, only 2.4 workers are projected to contribute per beneficiary, down from 3.4 in 2000. This demographic shift is expected to create a staggering annual shortfall of $332 billion by 2035 if current benefit rules and revenue streams remain unchanged. The Social Security trustees project that the combined retirement and disability trust fund will be depleted by 2035, marking a critical turning point for the program.

While Social Security will continue to collect over $1.6 trillion annually in payroll taxes and income taxes on benefits, it’s projected to cover only 83% of scheduled benefits in 2035, potentially dropping to 73% in the future. This shortfall threatens the financial security of millions of Americans who rely on these benefits.
The root cause of this crisis lies in the growing imbalance between Social Security’s dedicated revenues and its scheduled benefit payments. If benefits were paid as currently scheduled, program spending would surge from 5.1% of GDP in 2024 to 6.7% by 2098, while revenues would stagnate around 4.5% of GDP during the same period.
To address this looming crisis, policymakers face tough choices: significantly increase fertility rates, raise tax rates or expand the tax base, or allow replacement rates to decline over time. The urgency for reform cannot be overstated, as failure to act could result in a more than 50% increase in the number of Social Security beneficiaries living in poverty, with a disproportionate impact on Black and Hispanic communities. The future financial stability of millions of retirees and disabled Americans hangs in the balance, demanding immediate and decisive action to safeguard this vital social safety net.
Could personal savings replace part of our tax system? Here's what experts are saying
The current U.S. Social Security system, based on a tax and transfer model, offers guaranteed retirement income but faces significant challenges. While popular for its defined benefit structure and progressive formula benefiting low-income earners, the system is vulnerable to economic downturns and offers lower returns compared to potential personal savings. It limits individual investment choices and risk management options, potentially discouraging private saving. The system’s reliance on payroll taxes from a shrinking workforce relative to retirees raises concerns about its long-term sustainability.
Despite these drawbacks, Social Security remains a crucial part of retirement income for many Americans, representing about 30% of total income for those 65 and older. However, it limits intergenerational wealth transfers and may crowd out private saving. Potential reforms, such as personal savings accounts, could address some of these issues but would introduce new complexities. The challenge lies in balancing the system’s social safety net function with the need for financial sustainability and individual choice in retirement planning.
What past reforms teach us about fixing today's systems
The 1983 Social Security reforms, enacted in response to a severe financial crisis, implemented significant changes including raising the retirement age, increasing payroll taxes, and taxing benefits. While these measures temporarily restored the system to surplus, they failed to address the fundamental long-term challenges posed by demographic shifts and the wage-indexed benefit formula. Despite the reforms, projections soon indicated future deficits, highlighting the need for more comprehensive solutions to ensure the program’s long-term sustainability.

Reforming replacement rates: A critical step toward secure retirements
The 1977 Social Security amendments introduced wage indexing for benefit calculations, which inadvertently set the system on a path of financial instability. In 1976, the Hsiao panel recommended price indexing instead of wage indexing to address skyrocketing replacement rates and potential chronic deficits. However, the Carter administration opted for wage indexing, leading to the current system. Converting to price indexing could significantly improve Social Security’s financial outlook, potentially resulting in surpluses and allowing for tax reductions or support for other programs like Medicare. Contrary to expectations, replacement rates are projected to rise at every wage level under the current system, despite the formula being designed to provide lower replacement rates to higher wage workers.
The Bowles-Simpson proposal: A controversial plan for saving Social Security
The 2010 National Commission on Fiscal Responsibility and Reform, led by Alan Simpson and Erskine Bowles, proposed a comprehensive bipartisan plan to address Social Security’s financial challenges. The plan recommended a combination of spending cuts and tax increases, including changes to Social Security benefits and retirement age.
Key proposals included gradually raising retirement ages, making the benefit structure more progressive, and expanding benefits for low-income workers. The plan would have slowed benefit growth for high-income earners while providing enhanced benefits for minimum wage workers. It also proposed switching to a chained CPI for cost-of-living adjustments and gradually increasing the payroll tax cap. Despite garnering some bipartisan support, the plan fell short of the required supermajority for implementation and faced criticism from both political sides. Are Recent Congressional Efforts Enough to Save Social Security?
Senator Bill Cassidy (R-LA) has proposed a bipartisan Social Security reform plan. His core idea involves the federal government borrowing $1.5 trillion to invest in the stock market, with proceeds directed to Social Security. While well-intentioned, critics argue this approach is effectively a tax increase in disguise and comes with considerable risk and instability to federal government finances.
Cassidy’s “Big Idea” proposal would create a separate fund to invest in private markets, aiming to generate returns that could cover three-fourths of Social Security costs over the next 75 years. He points to successful models in private pensions and the Canada Pension Plan as examples.
Cassidy highlights that Social Security accounts for 20% of the nation’s future indebtedness, with 10,000 Baby Boomers becoming eligible for Social Security or Medicare daily. He notes that while discretionary spending has remained constant as a percentage of the budget, entitlements are exploding.
Democratic proposals, such as those from Congressman John Larson and Senator Bernie Sanders, focus on applying payroll taxes to higher incomes and expanding benefits. However, these plans do not fully address the long-term structural deficiencies in the program.
Ultimately, payroll tax changes alone are insufficient to ensure Social Security’s fiscal sustainability. Lifting the payroll tax cap entirely would cover only about half of the shortfall and could have negative economic impacts due to significantly higher marginal tax rates.
Citations:
https://www.wwno.org/2024-12-19/senate-to-decide-on-social-security-boost-for-public-sector-workers
https://riponsociety.org/2024/09/cassidy-outlines-bipartisan-plan-to-keep-social-security-solvent/
https://www.aei.org/op-eds/bill-cassidys-well-intentioned-but-misguided-social-security-reform/
https://fiscaldata.treasury.gov/americas-finance-guide/national-debt/
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