For most Americans, Social Security will play an important role during their retirement. According to a 2022 Gallup survey, 89% of existing retired workers lean on their monthly Social Security payout to cover their expenses. For the 20 years Gallup has conducted its annual survey, at least 80% of seniors have noted that Social Security is, to some degree, a necessary income source.
Unfortunately, this financial lifeline for so many retirees, survivors of deceased workers, and workers with disabilities, is facing its own financial turmoil. In order for Social Security to be shored up for future generations, elected lawmakers are going to have to act sooner than later -- and it all starts at the top with President Joe Biden.
President Joe Biden delivering remarks. Image source: Official White House photo by Katie Ricks.
Social Security is contending with a long-term funding shortfall in excess of $20 trillion
For more than eight decades, Social Security has, without fail, paid retired worker benefits and provided some level of financial foundation for those who can no longer work. But in 2021, the program's pendulum swung the wrong direction for the first time in nearly four decades. More specifically, it paid out more in benefits than was collected in revenue.
This shift from Social Security consistently bringing in more revenue than it pays out is the result of numerous demographic changes taking shape. Some of these you're probably familiar with, such as baby boomers leaving the workforce in greater numbers. But other changes might not be so readily apparent.
Other demographic changes that are adversely impacting Social Security include a near-halving in net immigration into the country since mid-1997, historically low birth rates in the U.S., and growing income inequality.
Since 1985, the annually released Social Security Board of Trustees Report has predicted that there wouldn't be enough revenue collected by the program over the next 75 years (following the release of each report) to cover outgoing benefits. As of the 2022 Report, Social Security's long-term funding shortfall stood at a staggering $20.4 trillion.
Based on estimates provided by the Trustees, the Old-Age and Survivors Insurance Trust Fund (OASI), which is responsible for doling out checks to 48.5 million retired workers each month, is facing a potential benefit cut of 23% by 2034 if lawmakers fail to make changes to the program.
However, President Biden believes he has the solution.
President Biden wants to increase taxes on high earners to strengthen Social Security
Prior to being elected president in November 2020, Biden released a four-point proposal designed to strengthen Social Security for future generations. This included changing the program's measure of inflation, boosting the primary insurance amount (PIA) for beneficiaries from ages of 78 through 82, and increasing the special minimum benefit. But the flagship change offered in Biden's Social Security plan is to increase payroll taxation on the rich.
In 2023, all earned income between $0.01 and $160,200 is subject to Social Security's 12.4% payroll tax. By "earned income," I mean wages and salary, but not investment income. If you work for a company or someone else, you and your employer split the liability for this tax down the middle (6.2% each). If you're self-employed, you owe the entirety of the 12.4%.
Approximately 94% of working Americans earns less than the maximum taxable earnings cap (the $160,200 figure). Put another way, 94% of workers are paying into Social Security with every dollar they earn this year. On the other hand, roughly 6% of high earners are expected to top $160,200 in earned income in 2023. All wages and salary above this threshold are exempted from the payroll tax.
Based on data from the Social Security Administration, the percentage of earned income subject to Social Security's payroll tax has declined from 90% in 1983 to just 81.4% as of 2021. As noted by a recently published blog from the Economic Policy Institute, that's the lowest level of earnings being subjected to the payroll tax in 49 years. More importantly, it's confirmation that wage growth for high-earning workers is outpacing the near-annual increase in the maximum taxable earnings cap for Social Security's payroll tax.
The solution offered by then-presidential-candidate Biden was to reinstate the payroll tax on earned income above $400,000, while creating a doughnut hole between the maximum taxable earnings cap and $400,000 where earnings would remain exempt. Over many decades, this doughnut hole would completely close as the maximum taxable earnings cap rises with the National Average Wage Index.
Biden's proposal, if passed, would immediately boost revenue for Social Security, with the goal of pushing back the OASI's potential asset reserve depletion date well beyond 2034.
Image source: Getty Images.
Would taxing the rich really save Social Security?
On paper, increasing taxation on a larger percentage of earned income sounds like an easy solution to strengthen Social Security. The question is, "Would it work?"
In October 2020, Washington, D.C.-based think tank Urban Institute examined Joe Biden's various Social Security and Supplemental Security Income proposals and estimated their impact on the program. According to the findings, Biden's proposal would close around a quarter of Social Security's long-term funding shortfall. However, the solvency of the asset reserves would only be extended by about five years.
Although taxing the rich would, indeed, raise a lot of extra revenue for Social Security, Biden's other reforms would offset most of this boost. Altering the program's inflationary tether to the Consumer Price Index for the Elderly (CPI-E) would lead to higher annual cost-of-living adjustments. Additionally, increasing the PIA for older beneficiaries, as well as the special minimum benefit, reduces the impact of raising payroll taxes on high earners.
The other dilemma with increasing payroll taxation on the rich is that they're arguably already paying their fair share.
Social Security retirement benefits are calculated based on earned income up to the maximum taxable earnings cap in a given year. Likewise, maximum retirement benefits are capped at full retirement age ($3,627 per month in 2023). Hypothetically speaking, you could earn $10 million a year for the 35 years the Social Security Administration takes into account when calculating your retirement benefit, but your maximum monthly benefit wouldn't exceed $3,627 at full retirement age in 2023. In other words, it doesn't make a lot of sense to tax earned income that has no bearing on a worker's retirement benefit.
While some form of higher taxation will likely be needed to strengthen Social Security in the coming years, simply "taxing the rich" as the sole solution isn't going to fix Social Security or come anywhere close to resolving its $20.4 trillion funding shortfall.
