(The Motley Fool) - This is a potentially bittersweet moment for Social Security's nearly 66 million beneficiaries. On one hand, they're just a couple of weeks away from receiving the largest cost-of-living adjustment (COLA) on a percentage basis in 41 years. For the program's more than 48 million retired workers, the average monthly Social Security check is expected to climb by $146 in 2023.
KEY POINTS
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It's looking increasingly likely that the U.S. will enter a recession sometime in the not-so-distant future.
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Social Security's abundant asset reserves protect monthly benefit checks from being harmed by a recession in the short term.
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However, recessions can have three notably negative impacts on America's top retirement program.
Medicare Part B premiums are also declining year over year. As a result of these changes, many retirees are looking at a real-money increase in their take-home benefit for the new year.
On the other hand, the winds of recession appear to be blowing in the United States. Although retail sales and the unemployment rate aren't throwing up red flags, the biggest inversion in the interest-rate yield curve in 40 years certainly is. With the Federal Reserve increasing interest rates at the fastest pace in decades, the likelihood of a recession in the U.S. in 2023 has steadily grown.
The $64,000 question is: Would a U.S. recession be potentially crippling to Social Security? Let's take a closer look.
A recession would pose no threat to Social Security in the short run
The short answer is that, yes, recessions do have an impact on Social Security. However, they pose no immediate risk to America's top retirement program.
Easily, the biggest reason Social Security is in no danger in 2023 (or the next couple of years, for that matter) of seeing benefits impacted by a recession is its asset reserves -- i.e., the amount of excess cash built up since inception. On a combined basis, the Old-Age and Survivors Insurance Trust Fund (OASI) and Disability Insurance Trust Fund (DI) had nearly $2.81 trillion invested in special-issue bonds and certificates of indebtedness as of the end of November 2022.
By law, the excess revenue collected by Social Security is required to be invested in these special-issue bonds and certificates of indebtedness, which earns the program interest from the federal government. With a boatload of asset reserves, there's absolutely no concern that a recession, regardless of severity, would interrupt payouts or hurt Social Security's very short-term outlook.
What's more, Social Security generates approximately 90% of its revenue from the 12.4% payroll tax on earned income, which includes wages and salary, but not investment income. As long as people keep working and lawmakers on Capitol Hill don't change how Social Security generates revenue, there will always be revenue coming in for disbursement to eligible beneficiaries.
Recessions can adversely impact Social Security's long-term financial health three ways
However, recessions can have three very specific adverse impacts on the financial stability of Social Security over longer periods of time.
U.S. NET PAYROLL TAX CONTRIBUTIONS TO OLD-AGE, SURVIVORS, AND DISABILITY INSURANCE TRUST FUND RECEIPTS DATA BY YCHARTS.
1. Payroll-tax revenue often takes a hit
As noted, the payroll tax, which'll be applicable on earned income between $0.01 and $160,200 in 2023, brings in most of the program's revenue. During recessions, it's not uncommon for the unemployment rate to rise and for workers to lose wage-bargaining power.
For example, payroll-tax collection from the combined OASI and DI declined from $672.1 billion in 2008 to $637.3 billion in 2010, during and following the Great Recession (2007-2009). While this might not sound like a big deal, benefits paid by Social Security continue to climb every year.
This is a particularly big deal, considering the annually released Social Security Board of Trustees Report has been cautioning since 1985 that not enough revenue would be generated to cover payouts, inclusive of COLAs, over the long term (which is defined as the next 75 years). In the 2022 report, the Trustees estimate a 23% cut to benefits may be necessary for the OASI as soon as 2034 to sustain payouts through 2096 without any further cuts. If a recession adversely impacts payroll-tax collection, it could accelerate the timeline to reduce benefits.
2. A weaker labor market likely means less taxation of benefits collected
A second way U.S. recessions can adversely affect Social Security is through the taxation of benefits. Yes, based on modified adjusted gross income plus one-half of benefits received, your current or future Social Security benefit may be taxable if it crosses above preset income thresholds.
Building on the point above, a recession has the potential to slow or halt wage growth, as well as increase unemployment or reduce the earning capacity of workers. That's bad news for the taxation of benefits. But keep in mind that the taxation of benefits accounted for just 3.45% of the $1.088 trillion collected by Social Security in 2021.
3. Social Security's interest-earning potential can decline
The third way a recession can negatively impact Social Security is through interest rates. With close to $2.81 trillion of asset reserves invested in bonds and certificates of indebtedness, Social Security benefits most when interest rates are rising. During most recessions, the nation's central bank lowers interest rates to spur economic activity and lending, which can reduce the net interest income generated by Social Security.
The interesting thing about the current economic environment is that the Fed has had no choice but to aggressively tackle historically high inflation by raising interest rates. This means a potential recession next year may not be met with monetary easing, as it has been so frequently in the past.
Just understand that this isn't the norm. When recessions arise, the Fed usually reduces interest rates, which hurts Social Security's interest-income generating capacity.
Your Social Security silver lining
But there's one last thing to note about recessions in the United States: They typically don't last very long.
Based on data from the National Bureau of Economic Research, the average U.S. recession between 1854 and 2022 has lasted just 17 months (one year, five months). Since 1950, the average recession length has shrunk to a mere 10 months.
While averages can't predict precisely how long a recession will last, it does provide pretty clear evidence that periods of economic expansion last considerably longer than recessions in the United States. Whatever adverse effects Social Security contends with from a potential recession are likely to be short-lived. Fixing the program's $20.4 trillion estimated cash shortfall through 2096 is a far-more-pressing concern.
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By Sean Williams
December 15, 2022
