For Social Security beneficiaries, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) is best known for the COVID-19 stimulus money it provided. But the CARES Act did more than just authorizing direct payments to individuals and families.

One of the provisions of the CARES Act enables employers (and self-employed workers) to defer paying the employer's portion of payroll taxes. While this part of the Act isn't getting a whole lot of attention, especially by Social Security recipients who've mostly left the workforce and payroll taxes behind, its effect on Social Security's finances shouldn't be overlooked. 

Old man grabbing piggy bank away from outstretched hands.

Image source: Getty Images.

Social Security is being deprived of an important source of funds

Payroll taxes are the primary mechanism by which Social Security is funded. These taxes total 12.4% and are split evenly between workers and employers, each of whom pays 6.2% annually. 

In 2019, Social Security collected a total of $944.5 billion in payroll taxes to fund retirement benefits, survivor benefits, and disability benefits. This accounted for 89% of the program's funding. In 2020, it's likely to collect a lot less because coronavirus is leading to record unemployment. And the CARES Act's provisions allowing employers to defer payroll taxes will deplete this funding source further.

Under the Act, employers have the option to defer the payment of Social Security tax they'd normally have to pay between March 27, 2020 and Dec. 31, 2020. Those who are self-employed normally have to pay both the employer and employee portion of payroll taxes, and they can also defer payment of the employer portion during this period. 

And while it's true that employers eventually have to pay these taxes, they have a lot of extra time to do it -- until Dec. 31, 2021 to pay 50% of the deferred amount and Dec. 31, 2022 to send the remainder.

Why does this damage Social Security?

When Social Security released its most recent trustees report, it projected that 2021 would be the first year since 1983 when the program had net cash outflows. But the report was prepared before the coronavirus crisis began. 

Thanks to record high unemployment and the fact that no payroll taxes are collected on jobless benefits, it's more likely the program will run a deficit this year rather than next. And the fact that employers can defer payroll tax payments just increases the chances of this happening. If employers take advantage of the opportunity, Social Security will only collect half the expected payroll taxes for employees still on the job.

More money will have to come out of the trust fund because of this, with less going in. This is a problem because Social Security invests the trust fund reserves in Treasury securities, which earned an average rate of 2.2% in 2019. While employers will eventually pay back the payroll taxes, the program will have lost the chance to invest the money it didn't collect during the years when payments were deferred. An interest rate of 2.2% may not seem like much, but when you're talking about billions of dollars, it can add up very quickly.

Since the trust fund is already in trouble and expected to run out of money in 2035, missing out on this interest income is only going to make the program's financial problems worse. 

Current and future retirees need to prepare for the possibility of benefit cuts

Unless changes are made, the Social Security trust fund is going to run out of money soon, and possibly within the next decade.

This doesn't mean that no benefits will be paid, as payroll taxes will keep coming after the trust fund runs dry and can be used to send out payments. But those simply aren't enough to cover all the promised benefits, so if changes aren't made, retirees could see steep cuts as high as 24%

While lawmakers could make changes to prevent this, finding a solution is politically difficult because it would likely mean raising taxes, raising the retirement age, or cutting benefits -- none of which are popular. Still, COVID-19 is definitely going to hasten the day of reckoning, and the CARES Act's payroll tax relief is only going to make things even worse. Lawmakers need to recognize this problem and act sooner rather than later, as the longer they wait, the worse the options become for shoring up the program's finances.