Though up for debate, because Medicare is relied on extensively by retirees, no social program tops Social Security in overall importance. Data from the Social Security Administration shows that more than three out of five aged beneficiaries depend on the program for at least half of their monthly income, with about a third leaning on it for virtually all of their income (90% to 100%). Social Security is also responsible for keeping an estimated 15.1 million retired workers out of poverty.
Unfortunately, this crucial program is on a collision course with disaster, according to the latest annual report from the Social Security Board of Trustees.
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Social Security's judgment day is quickly approaching
It's been 35 years since lawmakers in Washington last overhauled Social Security, and they've known for about the last 30 years that additional action would need to be taken to shore up the program's finances at some point in the future. That moment is now rapidly approaching.
The newly released Trustees report finds that a major change is underway right now. Though last year's report had singled out 2022 as the point where Social Security would begin paying out more in benefits than it generates in income, the latest report finds that this shift is set to occur this year, with an estimated $1.7 billion more in benefits being paid out than will be generated from the program's three funding sources.
With this deficit expected to grow in each and every year (with the exception of 2019), according to the intermediate-term cost model, Social Security's $2.9 trillion in asset reserves are projected to be completely exhausted by 2034. Between 2034 and 2092, the program is staring down an estimated $13.2 trillion cash shortfall.
On the bright side, even if Social Security completely uses up its excess cash, the program can remain solvent ad infinitum. The 12.4% payroll tax that working Americans pay on their wage income of up to $128,400, as of 2018, ensures that America's most important social program always has revenue rolling in that can be disbursed to eligible beneficiaries.
On the other hand, the fact that Social Security is starting to burn through its asset reserves is a sign that the current payout schedule isn't sustainable. If its asset reserves are completely exhausted, an across-the-board cut in benefits of up to 21% may be needed to sustain payouts through the year 2092. Keeping in mind how reliant today's beneficiaries are on Social Security, a 21% reduction in benefits could prove devastating.
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Raising payroll taxes on all working Americans could fix Social Security
Now here's the real kicker: Fixing Social Security could be done very easily, and in a variety of ways. One such method involves raising the payroll tax on all working Americans and employers.
As noted, Social Security's payroll tax is 12.4% on earned (wage) income between $0.01 and $128,400, as of 2018. This means that any earned income above $128,400 is exempt from the payroll tax (but not the Medicare tax). Generally speaking, more than 90% of all working Americans pays into Social Security with every dollar they earn.
However, a majority of working Americans aren't paying the full 12.4% payroll tax. If you're employed by someone else, your employer is responsible for half of your payroll tax, based on your earned income, with you, the worker, covering the other half (6.2%). If you're self-employed, then you're on the hook for the full 12.4% payroll tax.
One the simplest ways to fix Social Security is simply to increase the aggregate payroll tax on all workers. The Trustees report notes that the long-term (75-year) actuarial deficit for the program is 2.84%, up 0.01% from the previous year. In plainer English, the Trustees are estimating that a 2.84% increase to the payroll tax today would completely resolve the aforementioned $13.2 trillion cash shortfall and allow benefits to continue without any cuts, at least until 2092. This implies a payroll tax of 15.24% (12.4% plus 2.84%) for the self-employed, and a split liability of 7.62% between employers and employees. On an overall basis, we're talking about an increase in a workers' payroll tax liability of 23%, compared to what they're paying today.
It is worth pointing out that the Trustees report also lists what's known as a "necessary tax" of 2.78%, with regard to the payroll tax. This necessary tax is what percentage increase is needed in the payroll tax today to make it to 2092 without any benefit cuts, but also without any asset reserves at the end of the period. The actuarial deficit of 2.84% would allow the program to end 2092 with a year's worth of expenditures saved up as asset reserves. Just as you wouldn't walk around without any money in savings, it's only logical that America's most important social program has money in reserves, too. Thus, why I'm choosing to use the actuarial deficit figure.
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Two payroll tax quirks
Of course, nothing can ever be cut-and-dried when it comes to Social Security, so let's also touch on two notable quirks of adjusting the payroll tax.
First of all, increasing the payroll tax on all workers still wouldn't address the fact that approximately $1.2 trillion in annual wage income is exempt from the payroll tax. Since the payroll tax caps at $128,400, and this figure is only adjusted on par with the National Average Wage Index each year, the wealthy would still be able to avoid the payroll tax on a significant portion of their income. Essentially, an across-the-board payroll tax increase would wind up being a hit to low- and middle-income workers and their families, whom Social Security is designed to protect.
The other notable quirk is that the longer lawmakers wait to act, the costlier it'll be to completely fix Social Security. Let's face it, Congress doesn't exactly resolve issues in a timely manner. Instead, lawmakers are known to kick the can down the road until an issue becomes pressing. In fact, the 1983 Social Security Amendments only came about because the program was less than a year away from exhausting its asset reserves. The longer Congress waits to increase payroll taxes on all working Americans, the more likely it becomes that the eventual fix could mean a 3% or larger aggregate increase.
Seemingly nothing is ever easy when it comes to Social Security, but increasing payroll taxes by 2.84% on all workers today would be a quick fix for the program.
