Social Security is in trouble. In April, the program's Trustees reported that Social Security's trust funds could run out of money by 2035. Once that happens, the program may have no choice but to cut benefits to compensate for a lack of revenue.
The bulk of Social Security's revenue comes from payroll taxes -- the ones everyone has to pay on earnings, up to a certain point. In the coming years, Social Security's primary revenue stream will shrink as more and more baby boomers end their careers and not enough people enter the workforce to replace them. As such, the program will owe more money in benefits than it can pay. It does have its trust funds to bridge that shortfall, but only for so long, and once those funds run dry, substantial benefit cuts may be on the table.
Of course, cutting benefits would be catastrophic to the many seniors who already rely on Social Security for the bulk of their income, and it could also be similarly harmful to future recipients who plan to do the same. As such, lawmakers are invested in a solution to prevent benefit cuts from happening, and increasing Social Security's primary revenue source -- payroll taxes -- has been a popular suggestion. But it's also a solution that's not nearly as feasible as it may seem.
Raising the wage cap
Right now, higher earners don't pay Social Security taxes on all of their earnings. Rather, there's a wage cap that changes from year to year and dictates how much earnings are subject to Social Security taxes.
For the current year, the wage cap is $137,700, which means earnings beyond that point don't help generate revenue for Social Security. It also means that someone earning $137,700 pays the same amount of annual Social Security tax right now as someone with a yearly paycheck of $2 million. With lawmakers being desperate to infuse money into Social Security, the idea of raising the wage cap is being tossed around as a viable solution for increasing payroll tax revenue.
But will it actually work? That part's debatable. While increasing the wage cap will clearly drum up revenue in the near term, what happens on the flipside, when higher earners start to retire and collect benefits of their own?
Social Security pays a maximum benefit to retirees that also changes from year to year. Currently, it's $3,011 a month at full retirement age. If lawmakers agree to raise the wage cap, it's only fair that the program would then have to pay out higher benefits in retirement to compensate. And that right there would effectively negate an increase in tax revenue.
Also, let's not forget that higher earners aren't apt to take kindly to higher taxes on their wages. And since the wealthy wield their share of political power, it won't be so easy to pass a proposal that displeases them to a substantial degree. In fact, even if Social Security were to raise the wage cap without increasing its maximum monthly benefit, thereby retaining its extra revenue, the political implications alone could be significant enough for lawmakers to back down on that sort of proposal.
Of course, it's too soon to tell what solution will be put into place, if any, to address Social Security's impending shortfall. The good news is that we're still years away from benefit cuts, which means lawmakers have some time to put their heads together. The bad news is that what may seem like an easy fix to a very large problem is actually anything but.