Social Security may be our nation's most successful and storied social program, but there's no beating around the bush anymore -- it's in big trouble.
Every year, the Social Security Board of Trustees releases a report that examines the current state of the program and analyzes its short-term (10-year) and long-term (75-year) outlook. The 2019 report projected that this year (2020) would be the first time we see Social Security expend more cash than it collects since 1982.
While this initial net-cash outflow will be relatively small, it's expected to grow exponentially in the years to come. By 2035, Social Security is expected to have completely depleted its $2.9 trillion in asset reserves (i.e., its net-cash surpluses built up since inception).
The silver lining for seniors and the long-term disabled is that Social Security doesn't need any money in its asset reserves to remain solvent. That's because two of the three funding sources for the program -- the 12.4% payroll tax on earned income and the taxation of benefits -- are recurring and responsible for 92% of the $1 trillion collected in 2018. In short, this means that Social Security cannot go bankrupt and will be there for you when you retire, whenever that might be.
But the other side to this tale is that shrinking asset reserves confirms the existing payout schedule is unsustainable without changes. To put this in easier-to-understand terms, Social Security retired-worker benefits are going to need to be cut across the board by as much as 23% in 2035 to fund payouts without interruption through 2093 (i.e., the long term).
Social Security needs a fix, and the American public is counting on its elected representatives in Washington, D.C. to make it happen.
However, this discussion ultimately starts at the top with the president of the United States. With Election Day now less than eight months away and four candidates still left in the race, the action plan of these candidates to fix and strengthen Social Security is squarely in focus.
A majority of the remaining presidential candidates support this Social Security fix
But what you might find surprising, or at the very least intriguing, is that all but one of the remaining candidates -- Donald Trump (R) -- support one very specific Social Security change to strengthen the program: raising the payroll tax earnings cap. This support comes from the likes of Sen. Bernie Sanders (I-Vt.), Rep. Tulsi Gabbard (D-Hawaii), and former Vice President Joe Biden (D).
As noted, the Social Security program has three sources of funding, but the 12.4% payroll tax on earned income is by and large the most important. It accounted for $885 billion of the $1 trillion in revenue collected in 2018. This year, all earned income -- that's wages and salaries but not investment income -- between $0.01 and $137,700 is subjected to the payroll tax, while all earnings above and beyond this upper limit, known as the payroll tax earnings cap, are exempt.
As a whole, 94% of working Americans earn less than the payroll tax earnings cap each year. This means these workers are effectively paying into Social Security on every dollar they earn. Meanwhile, a worker who earns $1 million in 2020 will pay into Social Security on the first $137,700, while close to 86% of their total earnings will remain untouched by this tax. Between 1983 and 2016, the amount of earnings that have been exempt from the payroll tax has skyrocketed from a little north of $300 billion to $1.2 trillion.
The three Democrats named above want to change this by raising the maximum taxable earnings limit. Although each candidate's strategy may differ a bit, the most commonly touted solution would be to create a doughnut hole between $137,700 and $250,000 where earned income would remain exempt, but reinstitute the 12.4% payroll tax on earnings above $250,000, thusly requiring the well-to-do to pay more into the program.
What's more, since the payroll tax earnings cap increases annually in step with the National Average Wage Index, this doughnut hole would eventually close over time, thereby subjecting all earned income to the payroll tax.
This Social Security change is a mixed bag of positives and negatives
The all-important question, though, is whether or not raising the payroll tax cap is a good idea. To this end, there's one very clear positive, but also some negatives, that the American public and these lawmakers may have overlooked.
The one clear positive associated with raising the payroll tax cap is that it would begin to provide an immediate resolution to the program's estimated $13.9 trillion cash shortfall between 2035 and 2093. This would be a major relief considering that the Republican's primary proposal to strengthen Social Security -- gradually raising the full retirement age -- would take decades before realizing significant cost savings.
Additionally, though the idea of taxing the rich may not appeal to everyone, it's the most popular solution with the general public. That's because an increase to the payroll tax cap would only affect up to 6% of working Americans, since the other 94% are already paying into the system with every dollar they earn.
But there are also drawbacks to arbitrarily increasing the payroll tax earnings cap. Perhaps the biggest is that the well-to-do are, arguably, already paying their fair share. The reason a payroll tax earnings cap exists is because Social Security also caps monthly benefits at full retirement age. Regardless of whether a worker averages $150,000 a year in earnings throughout their lifetime or $15 million annually, they wouldn't be able to collect more than $3,011 a month at full retirement age in 2020. Thus, it doesn't make much sense to collect tax on additional earnings without providing any additional benefit.
Another potentially big problem with the tax-the-rich strategy that's being proposed is that it ignores a number of ongoing demographic changes that could widen just how much money is needed to sustain the existing payout schedule. For instance, we've witnessed longevity increase substantially since the payouts first began eight decades ago, and over the past decade, birth rates among women of childbearing age have pushed to a record low. Net immigration levels are also down significantly from where they were two decades ago. The point is that even a windfall of additional tax revenue may not save Social Security benefits from being reduced.
Regardless of your stance on the issue, you'll certainly want to keep a close eye on election season. After all, Americans are extremely likely to be reliant on Social Security income to some degree when they retire.