In the wake of the continued debate about the “Build Back Better” bill, independent economists and financial think tanks alike have issued a humbling warning: the combination of rising federal debts, a pervasive deficit, and ongoing demographic trends are threatening the sustainability of Social Security benefits.
Before the global financial crisis of 2008, the United States enjoyed a debt-to-GDP ratio of roughly 35%. This ratio began increasing sharply for over a decade through a series of recovery measures. The U.S. Treasury had already flagged this trend as “unsustainable.”
Debt to GDP
Yet, the COVID-19 crisis called for increased emergency spending. The daring stimulus packages of 2020 and 2021 helped the economy avoid a further dip into recession. At the same time, they raised the debt-to-GDP ratio to historic peacetime records.
Furthermore, the federal deficit has not shrunk as quickly as was expected initially. In July 2021, the Congressional Budget Office projected a federal deficit of 13.4% of the GDP. This was barely a notch lower than the 2020 one, when the federal deficit rose to 14.9% of the GDP.
Simultaneously, the Old Age Survivors and Disability Insurance (or OASDI, the full name of the Social Security program) has seen a deepening imbalance between payers and payees. In layman’s terms, as the Baby Boom generation hits retirement age, there will soon be more people receiving Social Security benefits and fewer full-time workers paying into the system.
Social Security Exhausted by 2034?
Up to the year 2000, the Social Security system was supported solidly by a relatively young population, with more than three workers for every pensioner. This allowed the OASDI to build a surplus held in a trust fund and partially invested. But by 2020, this ratio had fallen to barely 2.7 workers per pensioner, and by 2040, it may fall below two workers per pensioner.
The result? A report by the Social Security Administration now predicts that “The Social Security Administration (2021) currently forecasts that the OASDI trust fund will be exhausted in 2034.” Current predictions show that each year’s income tax will only cover 78% of the OASDI’s expenses for any subsequent years.
According to economist James Poterba, one final factor affects the ongoing debt burden: raising real interest rates. These are the yearly interest rates offered by sovereign bonds, minus the past year’s inflation.
“Low real interest rates today reduce the burden of higher debt-to-GDP ratios, but they do not provide a warrant for a fiscal policy,” warns Poterba.
Rising Interest Rates
The United States (and most of the industrialized world) have seen relatively modest real interest rates over the past years. This is generally considered a good thing, as higher rates usually mean that the government will owe more money to foreign investors. In 2021, however, the Congressional Budget Office again rang the alarm: the U.S.’s real interest rates are expected to jump from 1.4% to 2% by 2031 and 5.2% by 2041. Each extra 1% point they increase translates to 2 to 3% more than the U.S. government will have to pay to Treasury bondholders.
For Edward Gamber, Emeritus Professor and analyst at Lafayette College, this rise will create an uncertain landscape that will lower business investments and consumer consumption.
The Future of Social Security
As it stands, the Treasury’s recommendations are stark. To keep the Social Security Trust Fund working, the debt-to-GDP ratio needs to stay below the 100% threshold until 2050, and fiscal revenues need to increase by at least 2.9% per year. Barring that, the younger generations may not collect the benefits promised today.
As it stands, already 42% of American workers who have not reached retirement age doubt they will get the current level of benefits. This pessimism may spur some towards private retirement schemes – but it may also tilt most voters’ hands for future election cycles.
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