Social Security is one of the most important sources of income for American retirees, but the program is in serious financial trouble. In fact, according to the most recent trustees' report, the combined trust fund for Social Security retirement, survivor, and disability benefits is likely to run short in 2035. This could lead to an across-the-board benefits cut of 21% because the program will only be able to pay benefits out of payroll taxes currently being collected when the money runs out.
Slashing benefits so much would be devastating to those who depend on their Social Security checks -- and it's not likely politicians will let such big cuts happen. The good news is, there are multiple ways to avoid this dire outcome, including these two proposed solutions that have long been under discussion.
1. Raising the payroll tax
Payroll tax is Social Security's primary funding source. This tax is split evenly between employers and employees who each pay 6.2% of the 12.4% total tax collected. Those who are self-employed pay the entire 12.4%.
Increasing the payroll tax would provide a much-needed influx of additional funds, but the bump in the tax rate to secure Social Security's financial stability would be a big one. According to the trustees' report, if payroll taxes were increased immediately and permanently, they'd have to jump to 15.54%. Employees and employers would each bear the brunt of this 25.2% tax increase when their rates jumped to 7.77% each. Self-employed workers would have to pay the entire added amount themselves with no employer to split the bill.
As unpleasant as this big tax increase would be, things only get worse if action isn't taken immediately. If lawmakers wait to raise payroll taxes until the combined trust fund is empty in 2035, the new rate would need to go up to 16.53% with employers and employees each paying 8.265% and self-employed workers once again getting stuck paying the entire amount. This 33.3% tax increase may not seem that painful but for workers earning around the median wage (which is $49,764 in 2020 and likely to be higher by 2035), it would mean employers and employees each owing more than $1,000 extra.
2. Raising the cap on income that is taxed
Another option to provide more payroll tax revenue would be to make more income subject to this tax. Currently, only a certain amount of income is subject to Social Security tax, with no payroll tax owed on income above an annual "wage base limit." In 2020, the annual wage base limit is $137,700.
Some experts have proposed either raising the cap or eliminating it altogether. And this would indeed help secure the program's financial future, as a 2019 report from Congressional Research Service found that if the taxable maximum was raised so 90% of earned income was taxed, this would eliminate around 30% of Social Security's financial shortfall. And if the cap was eliminated and all earned income was taxed, the trust fund would be solvent for 60 years.
However, one big reason Social Security is such a popular program is because there's a direct link between taxes paid in and benefits paid out. If the cap on income subject to tax was raised or eliminated but benefits didn't also go up, this link would be broken.
Will Social Security benefits cuts be avoided?
Each of these options are politically difficult and would be painful to the affected groups. But they may be more popular options than raising the retirement age, which is a de facto benefits cut that's seen a lot of opposition. Still, it's unclear what politicians will do to help shore up Social Security's finances, although it's almost certain they'll do something as a huge cut to benefits is likely to be the most unpopular option of all.