For the lion's share of retirees, Social Security is much more than just some check they've earned through decades of work. Rather, it's a crucial source of income that helps anywhere from 80% to 90% of current retirees make ends meet, according to more than 20 years of surveys conducted by national pollster Gallup.
However, the program paramount to retirees' financial well-being finds itself on ever-shakier ground.
Image source: Getty Images.
Demographic shifts are doing a number on America's top retirement program
Every year since 1985, the annually released Social Security Board of Trustees Report has cautioned that long-term revenue collection (i.e., the 75 years following the release of a report) wouldn't be sufficient to cover outlays (benefits, including annual cost-of-living adjustments, and administrative expenses). In the 2023 report, the Trustees pegged this funding obligation shortfall at a whopping $22.4 trillion through 2097.
If the fundamental issues leading to this shortfall aren't addressed in the somewhat-near future, Social Security's more than $2.8 trillion in asset reserves could be depleted, which would eventually lead to sweeping benefit cuts to sustain long-term payouts.
The reality is that there are a number of demographic shifts that are adversely impacting America's top retirement program. Some of these problems I've discussed in great detail, including a more than halving of legal immigration into the U.S. over the past 25 years, as well as historically low birth rates threatening to further weigh on a declining worker-to-beneficiary ratio.
But among the numerous demographic shifts hamstringing Social Security's financial future, none may be more prominent than its growing income inequality problem.
The rich are getting richer, to Social Security's detriment
In an ideal world, Social Security generates enough annual revenue to cover its expenses. This was the case between 1983 and 2020, which saw the program's asset reserves increase every year. Since 2021, Social Security has doled out more than it's brought in, which is depleting its asset reserves.
Last year, America's most successful retirement program collected $1.22 trillion. Although it generates some revenue by collecting interest income on its asset reserves, as well as from taxing a portion of Social Security benefits on select individuals and couples who earn more than preset thresholds, the bulk of the program's income comes from the payroll tax ($1.11 trillion in 2022).
The payroll tax is a 12.4% tax on earned income, which includes wages and salary but not investment income. If you're employed by someone else, you and your employer split this tax liability down the middle (6.2% each). Meanwhile, if you're self-employed, the onus of this tax falls entirely on you.
The quirk about the payroll tax is that not all earnings are subjected to it. In 2023, the payroll tax is applicable to all earned income between $0.01 and $160,200. This $160,200 figure is the maximum taxable earnings cap, and it tends to rise most years in unison with the National Average Wage Index. Earned income above this threshold is exempted from the payroll tax.
In an average year, 94% of working Americans will earn less than the maximum taxable earnings cap and, therefore, pay into Social Security with every dollar they earn. Meanwhile, the other 6% of working Americans will owe payroll tax up to this cap and then be exempted on any earned income above it.
In 1984, 91% of all earned income was subject to the payroll tax, according to Social Security's Annual Statistical Supplement. But as of 2021, only 81% of earned income was subject to the payroll tax. Even though a relatively consistent percentage of working Americans (around 6%) have some portion of income exempt from payroll taxation, the amount these high earners are bringing home has grown at a much faster pace than the maximum taxable earnings cap over the past 40 years.
Social Security's income equality problem is getting progressively worse and potentially "cheating" the program out of much-needed tax revenue.
President Biden delivering remarks. Image source: Official White House Photo by Hannah Foslien.
Joe Biden has a solution for Social Security's income inequality problem -- but there's a catch (or three)
This is a problem not lost on the highest office of government. Prior to becoming president, Joe Biden proposed a four-point plan to strengthen Social Security. The linchpin to its success is tackling income inequality head-on.
Though you can read about these four changes in greater detail, the eyebrow-raising proposal offered by then-candidate Biden was to create a doughnut hole between the maximum taxable earnings cap and the $400,000 where earned income would remain exempt from the payroll tax, and reinstate the payroll tax on earned income above $400,000. Since the maximum taxable earnings cap rises most years, this doughnut hole would eventually close down the road.
By addressing the well over $1 trillion in earned income "escaping" the payroll tax annually, Social Security would be able to generate a sizable amount of added annual revenue, which could possibly punt its asset reserve depletion date decades into the future.
But there's a catch (or three) with Biden's proposal to tackle worsening income inequality.
Specifically, an argument can be made that the rich are already paying their fair share. In addition to the cap on what earnings can be taxed, monthly benefits at full retirement age are also capped. Even if a worker hypothetically averaged $10 million in earned income annually for 40 years, the most they'd receive from Social Security at full retirement age in 2023 is $3,627/month.
Yes, this worker is unlikely to need Social Security income in any capacity during retirement. Nevertheless, their earned income is taxed in accordance with the maximum benefit they're eligible to receive (i.e., they're paying their fair share).
Another issue with Joe Biden's Social Security proposal is that it doesn't do as much as you'd think to extend the solvency of the program's asset reserves. Although taxing the rich would generate immediate income, Biden's suggestion to boost the payouts of aged beneficiaries and lifetime low earners, as well as switch the inflationary tether to one that increases annual cost-of-living adjustments, would offset most of the benefit of taxing high earners.
However, the biggest catch of all is that taxing the rich doesn't have enough support in Congress to be signed into law. Amending Social Security requires 60 votes in the U.S. Senate, and it's been 44 years since either party held that many seats in the upper house of Congress. Amending the payroll tax laws would require bipartisan support, and the vast majority of Republicans won't support taxation that specifically targets the highest earners.
Chances are that we're going to see Social Security's income inequality problem worsen, which is bad news for an already financially strapped retirement program.
