The 2019 Social Security Trustees report was recently released, and we got an updated look at the financial condition of Social Security as well as the latest projections for the future of the program.
As you might expect, the prognosis is not good. Although the report was generally a bit better than last year's, Social Security is still projected to run out of money in 2035. If this happens, a 20% across-the-board cut would be required for all current and future Social Security beneficiaries.
Obviously, nobody wants that to happen. However, getting Congress to agree on a solution to the problem is easier said than done. There are several different ways to tackle the problem, and not surprisingly, some are more popular with Democrats while others are more widely preferred by Republicans.
Having said that, one of the most easily quantifiable ways to solve Social Security would be an increase to the Social Security payroll tax rate. Currently, American workers and their employers each pay 6.2% of compensation, up to an annual maximum ($132,900 in 2019). Self-employed workers pay both sides of the tax -- employer and employee -- for a total rate of 12.4% of income, up to the same maximum that applies to employees.
So, let's take a look at how much we'd need to raise the Social Security payroll tax in order to fix the program once and for all, as well as some alternative solutions that could be considered.
How much of a tax increase would it take?
The short answer is that it depends if we decide to increase payroll taxes now or later. Keep in mind that Social Security gets income from three main sources: payroll taxes collected from American workers and their employers, interest income on reserves, and taxation of Social Security benefits paid out to retirees with certain income levels.
With that in mind, the Social Security Trustees estimates that in order to keep the program solvent for at least the next 75 years (the extent of the projection period), an immediate 2.70% increase in the Social Security payroll tax is needed. This would bring the total rate to 15.1%, up to the annual wage cap, or 7.55% each for employees and employers.
However, keep in mind that this makes certain assumptions. It assumes that the increase would be implemented immediately, as opposed to phased in over a period of years as many proposals have suggested. It also assumes that we're starting with about $2.9 trillion in reserves, which is currently the case. Remember that these reserves generate interest income for the program, and it's not an insignificant amount. In 2018, $83.3 billion of Social Security's income came from interest on the reserves. If we wait to implement a fix until these reserves are depleted, we would need a steeper tax hike to compensate for the lost interest income.
Over the long run, it's estimated that the costs of Social Security will exceed income by as much as 4.11% of taxable payroll if no changes are made. So, if we wait until the reserves run out before we fix the problem, we'd need a payroll tax increase of more than 4%, or 2% each for employees and employers. That's a big difference, and illustrates the need to act sooner rather than later to fix the problem.
Other ways to fix the problem
To be perfectly clear, there are additional ways to fix Social Security other than an immediate increase to the payroll tax. I already mentioned a gradual phase-in of a payroll tax increase (say, by 0.1% per year until the desired level is reached). In addition, some of the possible ways we could fix Social Security include, but are not necessarily limited to:
- Increasing or even eliminating the maximum taxable wage cap. In other words, make more of high earners' income subject to Social Security taxes.
- Raise the full Social Security retirement age, which is currently set at 67 for Americans born in 1960 or later.
- Reduce benefits for high-income retirees.
- Change the way cost-of-living adjustments (COLAs) are calculated to an index that rises more slowly.
- Some combination of the methods discussed here.
The sooner, the better
While a payroll tax increase is the example I've illustrated here, the most likely way Social Security will ultimately be fixed is by some combination of reforms. Even so, the point is that any of these fixes will be easier to swallow if they are implemented sooner rather than later. Social Security currently has almost $3 trillion in reserves and 16 years until it runs out of money, not to mention a projected surplus in 2019. It would be a smart idea to take advantage of this cushion while it's there.