Social Security is a go-to safety net during retirement for tens of millions of seniors. Even though the Social Security Administration (SSA) suggests that it's only designed to replace about 40% of the average retired workers' wages, most retirees lean on the program for much more. According to SSA data, 62% of elderly beneficiaries count on their monthly check for at least half of their income, with 34% leaning on Social Security for 90% or more.
Unfortunately, the program that seniors have come to rely on so heavily over the past couple of decades is nearing what can arguably be described as its biggest hurdle in history. Due to the ongoing retirement of baby boomers, which is weighing on the worker-to-beneficiary ratio, and a steady lengthening of life expectancies, Social Security's coffers are soon expected to be drained.
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According to the Social Security Board of Trustees report from earlier this year, the program will begin paying out more in benefits than it receives in income by 2022. Assuming Congress fails to enact any changes that generate more revenue, Social Security's nearly $3 trillion in asset reserves will be completely gone by 2034. This, in the eyes of the Trustees, would lead to an across-the-board cut of benefits to current and future retirees of up to 23%. That's not exactly a bright forecast with more than three out of five elderly beneficiaries reliant on Social Security for half of their income.
How to bridge a $12.5 trillion funding gap?
In order to "fix" Social Security's budget shortfall, which is estimated at $12.5 trillion between 2034 and 2091, lawmakers would have to do one of three things: raise revenue, cut spending, or do some combination of the two.
Spending cuts include such solutions as cutting benefits on all retirees now, cutting benefits on all retirees in 2034, freezing the purchasing power of benefits (i.e., ending cost-of-living adjustments), and raising the full retirement age, which is a popular idea among congressional Republicans.
But the easier of the two solutions might just be to raise more revenue so benefits won't be cut for current or future retirees.
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Social Security is funded three ways:
- A payroll tax on earned income between $0.01 and $127,200 (as of 2017);
- Interest earned on the programs' $2.88 trillion in asset reserves;
- The taxation of Social Security benefits.
In the grand scheme of things, the latter two funding mechanisms don't account for much. The taxation of benefits (yes, your Social Security benefits may be taxable if you earn over a certain threshold) accounted for less than $33 billion of $957.5 billion in revenue in 2017, while interest income from special issue bonds and certificates of indebtedness added another $88 billion. More than 87% of Social Security's funding, and probably more like 95% of its funding by 2034 with the likelihood of interest income disappearing, comes from payroll taxes. This suggests tweaking the payroll tax would be the easiest way to fix Social Security.
Here's how much payroll taxes need to increase to keep payouts from being cut
The beauty of the 12.4% payroll tax on earned income is that as long as Americans are working, Social Security is being funded. This ensures that, short of Congress changing the way Social Security is funded, the program can never go bankrupt. What it doesn't do is ensure that payments can stay at their current levels. In order for that to happen, we'd need to see payroll taxes go up for working Americans.
How much, you ask?
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According to the Trustees report, the actuarial deficit over the long term, defined as 75 years, is 2.83%. This is another way of saying that if the aggregate payroll tax rose by 2.83% today, enough additional revenue should be added over the next 75 years that no cuts to payouts should be necessary. The Trustees are crystal clear in their projections that the longer lawmakers wait to act, the higher the aggregate payroll tax hike would need to be to cover the imminent budget shortfall.
On the surface, we'd be talking about a 15.23% tax (the current 12.4% plus 2.83%) on all earned income between $0.01 and $127,200 -- but it's not that simple. Quite a lot of working Americans wouldn't owe anywhere near this amount. Though the self-employed would be on the line for this higher payroll tax rate, employees of a company have half of their payroll tax liability paid by the employer. This means the liability for the average worker would rise from 6.2%, which is where it is now, to 7.615% of earned income. With the average household bringing home around $50,000 annually, this higher payroll tax liability would take nearly $708 extra out of paychecks a year.
Could the average American family survive without $708 in added payroll tax a year? It's tough to say given how poor saving rates are in this country. But taking into account how reliant Americans are on Social Security, the added tax would be somewhat of an investment in the future financial well-being of our retirees.
A far likelier solution
While a 2.83% increase in payroll taxes would be the cut-and-dried fix for Social Security, a more preferred solution by the American public (and Democrats) would be to increase or remove the maximum taxable earnings cap.
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You'll note that in 2017 all earned income up to $127,200 is taxable, but any income earned above this mark is free and clear of Social Security's payroll tax. The reason for this is because Social Security has a maximum monthly payout of $2,687 at full retirement age. In other words, it's not particularly "fair" to tax $10 million in earned income if a person is only going to receive $2,687 a month at full retirement age.
But there's a counterargument to this: The rich almost certainly aren't going to depend on Social Security income when they retire. This suggests that they could bear the brunt of increased taxation by removing or substantially increasing the maximum taxable earnings cap. If removed completely, Democrats suggest that Social Security's budget shortfall would completely disappear.
While the wealthy are unlikely to favor such a proposal, it's really popular with the average American. Nearly seven out of 10 respondents in an informal Washington Post survey in 2014 approved lifting or removing the maximum taxable earnings cap. But as we've often seen in the past, what a majority of the population prefers isn't always what happens in Congress.
For the time being, your guess remains as good as mine as to where any additional funding for Social Security could come from.
