Social Security crisis worsens

Bottom line

We lost a giant last month, as Alan Greenspan, the legendary former Chair of the Federal Reserve, passed away at the ripe old age of 100 on June 22. Nicknamed the “Maestro,” Greenspan’s more than 18-year tenure was, in my opinion, the highwater mark in the central bank’s 113-year history. As successful as he was there, however, arguably his most significant body of work came earlier, when he worked on extending the solvency of the Social Security trust fund in 1983. That effort led President Reagan to nominate him to lead the Fed.

Bygone era of bipartisanship The US Senate confirmed Greenspan in 1987 by a vote of 91 to 2. Contrast that with the recent confirmation of Chair Kevin Warsh. He was confirmed in May by the narrowest vote in the history of the Senate (54-45), with only one Democrat (John Fetterman, D-Pa.) crossing the aisle. 

Kavesh connection Greenspan completed his doctoral thesis at New York University in 1977. Through a quirk in fate, Greenspan and I shared a thesis advisor, Dr. Robert Kavesh, the chair of the economics department. In many conversations as I worked to complete my masters’ thesis in 1983, Kavesh and I would often discuss Greenspan’s published articles, which provided me with insight into the Maestro’s thought process.

Running out of money faster According to the Social Security Board of Trustees 2025 annual report, published last month, the trust fund will be completely depleted by 2032. That’s one year sooner than it forecast in 2025. Of course, this is not surprising, as Social Security’s problems have grown over the decades, largely due to demographic shifts, such as longer life spans, declining fertility rates and declining legal immigration. Without changes to the program, benefits will automatically be cut by 22%, affecting around 70 million Americans.

Back to the future President Reagan and Congress created the National Commission on Social Security Reform (known now as the Greenspan Commission) in 1981 to study the system and attempt to reverse the solvency crisis. This led to the Social Security Reform Act of 1983, which changed the tax and benefit formula by raising the retirement age from 65 to 67 (phased in over 37 years), increasing the fund to $3 trillion. The Greenspan Commission also accelerated increases in the payroll tax (FICA) rate, delayed the annual Cost-of-Living-Adjustment (COLA), subjected a portion of Social Security benefits to federal income taxes for higher-income recipients, and required all new federal employees and employees of non-profit organizations to pay into the system. 

Greenspan blazed a path for future presidents: 

• President Clinton The Omnibus Budget Reconciliation Act of 1993 increased the portion of Social Security benefits on which high-income retirees must pay taxes. 
• President George W. Bush During his second term in February 2005, Bush attempted to put Social Security on a more secure path by partially privatizing it. The reform proposal would have allowed Americans under age 55 the option to divert part of that tax into stocks and bonds. But that would have required massive government borrowing —  perhaps $2 trillion — to maintain payments to current retirees. With a lack of public support, Congress did not pass it. 
• President Obama He empowered the Bowles-Simpson Commission's attempt in 2010 to repeat Greenspan’s efforts. It proposed increasing the Social Security payroll tax and reducing benefits. But Obama was opposed to raising the retirement age, privatizing the fund and cutting benefits. Ultimately, it seemed he was concerned that the reform effort could harm his re-election bid in 2012, and the legislation stalled. 

Why is Social Security in trouble? Demographics. President Roosevelt signed the Social Security Act into law in 1935 to provide financial support for the elderly and disabled. During the Great Depression, many elderly Americans were left penniless. For 40% of retirees today, Social Security benefits provide at least half their income, and for 15% of retirees, benefits provide more than 90%. The program began with a 40-1 worker-to-retiree ratio: for every 40 people who were working full time and contributing their taxes, one person living until age 65 began to draw full benefits. In 1935, the average American died at 62 years of age.

Fast forward nearly a century and we’re blessed with greater health, due to advanced medical care, better nutrition and a commitment by many to exercise. As a result, life expectancy has soared by 27% to 79 years of age (women at 81.4 and men at 76.5). Herein lies the rub. The full retirement age is only 3% higher today at 67. Consequently, the worker-to-retiree ratio has shrunk from 40-1 at the program’s inception in 1935 to 3-1 now, on its way to an estimated 2-1 a generation from now, according to actuarial assumptions. 

Declining fertility While Americans are living longer, birth rates are rapidly declining, which exacerbates this demographic conundrum. Fertility peaked in 1957, at an average of 3.6 children per family. Today, that rate is less than half at 1.6 children per family, which is below the replacement rate at 2.1 children. So, we have fewer young working people supporting an aging group of retirees. 

Possible solutions To improve the solvency of Social Security for the next 75 years, Washington could follow Greenspan’s lead and phase in shared sacrifice with several key proposals over the coming decades:

• Increase and index the retirement age Raise the retirement age to 70 by 2050 and then index the full retirement age to future changes in life expectancy. People who are 50 or older now would be grandfathered.  We could narrow an estimated 14% of the long-term actuarial deficit by raising the retirement age by one year to 68, so an increase to 70 could eliminate an estimated 43% of the deficit. 
• Increase tax rates and the wage cap Social Security is funded with a 12.4% payroll tax (paid half each by the employee and the employer) on wages up to the taxable earnings cap, which increased by a compound annual rate of 5.3% over each of the past five years to $184,500 in 2026. This wage cap is subject to an automatic annual adjustment, based on increases in the national average wage index. Perhaps the payroll tax rate can be expanded gradually from 12.4% now to 15% over time. Some members of Congress advocate eliminating the wage cap, but that would disproportionately harm the top 10% of taxpayers, who already pay more than 70% of income taxes and who account for more than one-third of GDP growth. 
• Fix the inflation calculation Cost-of-Living Adjustments (COLAs) are made with nominal current-dollar CPI, which economists believe overstates inflation by a quarter-point annually, compared with the core chained price-index CPI. That change in how wage benefits are adjusted could fix an estimated 20% of the long-term Social Security trust fund deficit.   
• Means testing benefits We are reasonably certain that Elon Musk and Jeff Bezos don’t need a monthly check from Social Security to make rent. While we are unsure where to draw the line, perhaps we can tax benefits of high-net-worth individuals at a higher rate.  
• The potential for better returns on trust assets Although he couldn’t get his proposal through Congress, President Bush was on the right track in my opinion. A traditional 60/40 portfolio mix with blue chip dividend stocks and Treasury bonds would have generated an annual return of around 7% over the past century, well above the negligible returns generated by Treasury’s management of the assets.  
• Expand legal immigration Given our demographic challenges, expanding legal immigration would increase our pool of workers, boost GDP growth and contribute to the Social Security trust fund through their tax payments. Because of the dearth of native-born workers, we need immigrants, especially in certain industries such as agriculture, hospitality and construction. We need expertise everywhere, of course, and we are proudly a nation of immigrants since our founding 250 years ago.
• Enhanced savings programs Encourage participation in IRAs, 401(k)s, 529s, Roth IRAs and the new Trump Accounts to reduce the reliance on Social Security.
• Enact term limits in Congress Our politicians refuse to make the hard decisions because they are more interested in extending their political careers in Washington. If we established 12-year term limits, our Senators and Representatives might very well pivot to doing the right thing for their constituents.

Six years from the brink Through a combination of thoughtful planning, shared sacrifice, and statesman-like leadership, Social Security can be successfully reformed and placed on a sustainable trajectory. That was Greenspan’s successful legacy under President Reagan more than 40 years ago. Congress and President Trump must now make more meaningful decisions on raising the retirement age, tax rate increases and privatization, among other possible changes, to pull Social Security back from the edge of the cliff. 

Read more about our views and positioning at Capital Markets.

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