John Cochrane (The Grumpy Economist) sets the stage:
The ups and downs of the [Social Security] trust fund just reflect a change in how we finance spending. While payroll taxes > social security spending, which was the case until 2007, then payroll taxes are financing other spending. When payroll taxes < social security spending, then income taxes or increases in debt are financing social security spending, which (graph below) was the case after 2008.* The trust fund just adds up this change over time. But exhausting the trust fund is, in this view, really irrelevant.
source: CBO
That doesn't mean we can all go to sleep, for two reasons. First, when payroll taxes < Social Security outlays, and the trust fund is winding down, then income taxes or additional public debt must finance the shortfall. The government has to spend less on other things, raise income tax receipts, or borrow which means raising future taxes. And, per the graph, the numbers are not small. 1% of GDP is $230 billion. The extra strain on income taxes, other spending, or debt, happens right now, when the trust fund is positive but decreasing.
Zero matters only because by law, when the trust fund goes to zero, Social Security payments must be automatically cut to match Social Security taxes. That's the sudden drop in the graph. The program was set up as if the trust fund were buying stocks and bonds, real assets, and would not lay claim on income tax revenues. But it was not; social security taxes were used to cover other spending, and now income taxes must start to pay social security benefits.
What happens when the trust fund runs out, then? Congress has a choice: automatically cut benefits, as shown, or change the law so that the government can pay Social Security benefits from income taxes, or, more realistically, by issuing ever more debt, until the bond vigilantes come. (Or raise payroll taxes, or reform the whole mess.) I bet on change the law….
* In the end,
payroll taxes + income & other taxes + increase in public debt = Social Security spending + other spending.
The trust fund nets out. [See my post, “Social Security: A Primer”, for a thorough explanation of why the trust fund is a fiction.]
It is extremely unlikely that Congress and the president (regardless of party) will allow benefits to be cut. It is extremely likely that the law will be changed so that scheduled benefits can be paid in full. The resulting addition to the federal deficit, as Cochrane says, will be funded by higher income taxes and/or (more likely) the issuance of more debt. (There’s also the possibility of collecting more payroll taxes from high-income earners, but that would be a symbolic gesture with little practical effect on the government’s overall deficit.)
Social Security benefits will be left untouched regardless of the consequences for the cost of funding the government’s debt (i.e., interest payments) or the inflationary effects of a larger debt (monetization by the Fed). The very last thing that Congress and the president (whoever he/she is) will allow is a reduction in schedule benefits (except possibly for “the rich”.) (When I say “very last thing”, I mean that even if World War III occurs, Social Security benefits will remain intact.)
A report by the U.S. Government Accountability Office (GAO) puts the whole thing in perspective:
Primary Deficit and Total Budget Deficit, Actual and Projected
In GAO’s simulation, increasing primary deficits are driving spending and revenue trends.
Spending: Medicare, other federal health care programs, and Social Security are requiring an increasingly large share of federal resources. Under GAO’s simulation, spending for both major federal health care programs and Social Security would account for 85 percent of projected revenue in 2050, up from 63 percent in 2019.
Revenue: Average annual revenue as a share of GDP was lower over the last 20 years than in prior decades. From 2000 to 2021, revenue averaged 16.8 percent of GDP annually, compared to annual average of 17.9 percent of GDP between 1980 and 2000.
Given the way things have been going and will continue to go, the depletion of the mythical Social Security trust fund will be a fiscal non-event. And it won’t have any effect on Social Security benefits.