Big Picture
Social Security is essential for many Americans. Roughly 66 million people received benefits at the end of 2022. However, the program’s costs now exceed its income; the reserves for the fund are expected to be depleted by 2034, at which point the program will not be able to fulfill all of its scheduled payments. We have to make Social Security more financially sustainable to protect Americans' financial security.
Operative Definitions
Full retirement age: The age at which people are entitled to full Social Security benefits, which is currently 66 or 67.
Social Security trust funds: The two trust funds, the Old Age and Survivors Trust Fund and Disability Insurance Trust Fund, are portfolios of investments that were built up with excess tax revenue. The trust funds are being slowly drawn down to cover missing tax revenue.
Payroll tax: A tax imposed on employers and self-employed people as a percentage of salaries paid. Social Security is primarily funded by a federal payroll tax.
Means-testing: The practice of using someone's wealth or income as conditions of eligibility for social programs. It may also include adjusting benefits based on wealth and income.
Important Facts & Statistics
The Social Security program was established in 1935 with the Social Security Act to provide financial assistance to retirees, disabled workers and other eligible people. The program provides a crucial income source for many and continues to play a big part in providing financial aid and security to millions of Americans.
To fulfill payments, the program accumulates cash through the Federal Insurance Contributions Act payroll tax, which is deducted from gross pay. The tax is then directed towards the Social Security trust funds, which are composed of the Old-Age and Survivors Insurance and the Disability Insurance funds.
At the end of 2022, the program was providing benefits to roughly 66 million people: about 1 in 5 United States residents. Most of them were retired workers. The total cost of the program was $1.244 trillion and the total income was $1.222 trillion, the majority of the income coming from non-interest income.
According to short-range results, the total cost of the program has exceeded its total income beginning in 2021 and will continue in 2023 and all later years. By the end of 2032, the combined reserves are expected to decrease from $2.830 trillion to just $590 billion, which is almost an 80% decrease. This is in large part due to demographics. Life expectancy for a 65 year old has increased from 14 years in 1940 to over 20 years. While 2.8 current workers were paying Social Security taxes per retiree in 2022, that is expected to decline to 2.3 in 2035.
According to long-range results, without changes to Social Security, the level of combined reserves will be depleted in 2034. The report also states that at the time of reserve depletion, the income would be able to pay just 80% of the scheduled benefits.
3-Point Plan
(1) Means-testing Social Security or changing the benefit formula.
Social Security desperately needs a comprehensive approach to address its financial challenges. One potential solution is to means-test benefits, which means taking into account the other assets or sources of income of retirees. By considering recipients' actual need for Social Security benefits, the program can provide a stronger safety net for those who need it most while reducing expenditures on higher-income individuals. An alternative would be to adjust the formula for Social Security benefits to reduce the benefits of high earners during their working years.
(2) Raising payroll taxes.
Another strategy to address the financial strain on Social Security is to raise payroll taxes. Currently, the payroll tax is deducted from individuals' gross pay to fund the program. Increasing the tax rate can generate additional revenue to sustain the program's operations and meet future obligations. However, careful consideration must be given to ensure that the burden of higher taxes does not disproportionately affect low-income workers.
(3) Eliminating the payroll tax ceiling or removing exemptions.
Removing the payroll tax ceiling and taxing fringe job benefits is another way to address income inequality and generate additional revenue. Currently, the payroll tax is only applied to income below a certain threshold, leaving higher earners exempt from further contributions. Eliminating this ceiling would ensure a more equitable distribution of the tax burden and provide a reliable stream of income for the program. Taxing fringe job benefits can contribute to the financial stability of Social Security. As the nature of employment evolves, compensation packages increasingly include non-monetary benefits such as healthcare or retirement contributions. Taxing these fringe benefits would generate additional revenue for the program while adapting to the changing landscape of employment.
Why This Initiative Is Important
Social Security entitlements represent over 50% of the wealth of the bottom 90% of Americans. Further, tens of millions of Americans rely on Social Security for more than 90% of their income. A decrease in Social Security benefits would ravage older low-income Americans and seriously threaten the retirement prospects of current and future generations. Social Security is popular across the political spectrum, but the United States faces demographic headwinds that make Social Security unsustainable in the long term. Without political action to address the looming shortfall in Social Security funds, the United States will face a catastrophic failure to provide a minimum standard of living for tens of millions of older and disabled Americans. We have to act—now.
Economic Impact
For the nerds interested, let's get into the nitty-gritty details.
Means-testing Social Security could greatly affect the program's costs. The Center for Economic and Policy Research estimates that a $0.20 reduction in benefits for every dollar of non-Social Security income (for people who make more than $40,000 per year) would lead to 4.65% less total benefits being paid out, while not reducing benefits at all for the most needy Social Security recipients.
However, means-testing might reduce the incentive to save for retirement through means other than Social Security, which might have detrimental macroeconomic effects by reducing the national savings rate. If people are relying more on Social Security, they may save less. Means-testing might also substantially increase the cost of administering Social Security, which is currently about 1% of Social Security tax revenue.
Changing the way Social Security benefits are calculated to disfavor higher-income earners might have a similar effect on savings, while not necessarily increasing the bureaucratic load. For example, the Congressional Budget Office has evaluated several potential adjustments to the benefits formula that would reduce the rate of increase in Social Security benefits as working years income rises, finding that once phased in, these could potentially reduce total Social Security benefits by the tens of billions per year.
As for raising payroll taxes: one plan laid out as a possible solution by the Social Security Administration is the increase of the payroll tax to 16.2%, expressed as a percentage of taxable payroll, in 2035 through 2064 by increments ranging from 0.01%-0.12%, eventually reaching 20% in 2065. This results in the annual balance becoming positive in 2035 through 2052, after which it becomes negative again until 2065.
In 2024, the total Social Security program cost, based on the total payroll for 2021 and the provided respective rates, would be roughly $1.402 trillion, while the total program income would be $1.255 trillion. In 2035, the total program cost would be roughly $1.592 trillion, and the total income would be $1.617 trillion. In 2052, the total program cost would be roughly $1.638 trillion, and the total income would be $1.640 trillion. In 2065, the total program cost would be roughly $1.699 trillion, and the total income would be $1.972 trillion.
Now let's consider the effects of eliminating the payroll tax ceiling or removing exemptions. Under one proposal, the payroll tax maximum would be eliminated in 2023 and the full payroll tax would be assessed for earnings above the maximum, without increasing benefits for individuals based on this new taxation. The Social Security Administration estimates that this provision would extend the ability of the trust funds to pay full benefits until 2060.
Under a separate proposal, the taxable maximum would be raised yearly by 2% beginning this year and until the taxable earnings equal 90% of covered earnings. Additionally, benefit credit would be provided for earning up to the revised taxable maximum. The Social Security Administration projects that this proposal would decrease the gap between cost rates and income rates, allowing the program to continue scheduled payments until mid-2030, creating a path towards a more sustainable social security program.
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Acknowledgment:
The opinions expressed in this article are those of the individual author.