Although it's an unpleasant realization, it's one that working Americans and retirees need to come to terms with: Social Security is in trouble.
The silver lining for seniors is there's absolutely no concern about America's most successful retirement program going bankrupt or becoming insolvent. Social Security generates 90% of its revenue from taxing the earned income (wages and salaries but not investment income) of working Americans. As long as people keep working and paying their taxes, there will always be money available to disburse to eligible beneficiaries.
Nevertheless, Social Security's long-term funding shortfall is growing with each passing year, and current and future retirees are looking to Washington for a resolution. While President Joe Biden believes he has a cure for what ails Social Security, a deeper dive suggests the president's proposal will fall flat in more ways than one.
President Biden delivering remarks. Image source: Official White House Photo by Adam Schultz.
A more than $22 trillion funding shortfall awaits Social Security
Since the first retired worker benefit was paid in 1940, the Social Security Board of Trustees has published an annual report that examines the finances and outlook of the program. In particular, the Trustees Report provides an under-the-hood look at Social Security's "balance sheet," allowing anyone to see how the program brings in its revenue and where each and every one of those dollars ends up.
Additionally, the Trustees Report examines an assortment of demographic changes, as well as fiscal and monetary policy shifts, to determine what impact they might have on Social Security over the short term (the 10 years following the release of a report) and long term (75 years following the release of a report). The 2023 Trustees Report estimates that Social Security is facing a $22.4 trillion long-term funding obligation shortfall through 2097.
By the Trustees' estimates, the Old-Age and Survivors Insurance Trust Fund (OASI), which is responsible for doling out monthly checks to more than 49 million retired workers and nearly 5.9 million survivor beneficiaries, is expected to exhaust its asset reserves by 2033. If this excess cash built up since inception were to disappear, a sweeping benefit cut of up to 23% may be needed for the OASI to sustain payouts, without the need for any additional cuts, through 2097.
The lion's share of Social Security's issues can be traced to demographic shifts that include:
- Rising income inequality.
- A 57% decline in legal immigration into the U.S. over the past 25 years.
- Historically low U.S. birth rates.
- Increased longevity vastly outpacing the rise in the full retirement age.
- The ongoing retirement of baby boomers.
According to President Biden, the easiest way to tackle Social Security's shortcomings is to address the program's growing income inequality problem.
Joe Biden wants to strengthen Social Security by taxing the rich
As noted, Social Security brings in most of its revenue by taxing the wages and salaries of workers. The liability for the 12.4% payroll tax on earned income is split down the middle for employers and employees (6.2% each), while the self-employed bear the full burden of this 12.4% payroll tax.
However, not all earned income is subject to the payroll tax. In 2023, wages and salaries between $0.01 and $160,200 are liable. For the 94% of working Americans who bring home less than $160,200 annually, it means paying into Social Security with every dollar they earn.
On the other hand, earned income north of $160,200 is exempt from the 12.4% payroll tax. Though these high earners do pay into Social Security up until $160,200, every dollar in wages or salary beyond this maximum taxable earnings cap is exempt from the payroll tax.
As of 1984, Social Security's Annual Statistical Supplement shows that 91% of earnings were subject to the payroll tax. But as of 2021, the payroll tax was applicable to only 81% of earned income. Even though the maximum taxable earnings cap is increasing over time on par with the National Average Wage Index, the earning power of the rich has grown at a far faster pace. The end result is that more earnings than ever are "escaping" payroll taxation.
Joe Biden's solution to rising income inequality is relatively straightforward. He wants to create a doughnut hole between the maximum taxable earnings cap and $400,000, where earned income would remain exempt from the payroll tax, while reinstating the payroll tax on wages and salary above $400,000. Note: Because the maximum taxable earnings cap (the $160,200 figure in 2023) rises most years, the proposed doughnut hole would close over multiple decades and eventually expose all earned income to the payroll tax.
In addition to raising a substantial amount of revenue by taxing the rich, Biden's four-point Social Security proposal would also swap out the existing measure of inflation that determines the annual cost-of-living adjustment, increase the special minimum benefit for lifetime low-earners, and lift the primary insurance amount (PIA) for aged beneficiaries.
Image source: Getty Images.
A tax-the-rich strategy, by itself, is virtually certain to fall flat
While Biden's tax-the-rich proposal might sound like a winning strategy on paper and would undoubtedly have a lot of support from the 94% of working Americans paying into the program with every dollar they earn, it comes up short in a variety of ways.
To start with, a strong argument can be made that the rich are paying their fair share. While it's true that the percentage of earned income exempted from the payroll tax has increased substantially over the past four decades, it's also true that the Social Security Administration caps monthly retired worker benefits at full retirement age -- $3,627 in 2023.
In other words, a high earner could average $200,000 in wages or $20 million in wages over 35 years, and they'd still have no chance for a higher monthly benefit check from Social Security in 2023 than $3,627. The cap on monthly benefits exists because there's a cap on how much earned income can be taxed. By this definition, the rich have paid their fair share based on what they'll eventually be owed by the program.
A second issue with Biden's proposal is that any attempt to collect additional tax revenue on the rich would likely be met by some high earners shifting how they generate income. For instance, dividend income, capital gains, rental income (short of being a rental professional), bond income, and income from a certificate of deposit (CD) at a bank are all exempt from the payroll tax. It's possible we'd see high earners adjust how they generate income to reduce or eliminate any added tax liability.
The third and potentially biggest problem with Biden's tax-the-rich proposal to save Social Security is that the math doesn't add up. Washington, D.C., think tank Urban Institute ran the numbers on Biden's full four-point plan in October 2020 and found that it would add only five years to the solvency of the program's asset reserves. The president's additional proposals, such as increasing the PIA for aged beneficiaries, raising the special minimum benefit, and changing the inflationary tether, all substantially reduced the benefit of subjecting earned income above $400,000 to the payroll tax.
Furthermore, an analysis from the Social Security Administration's Office of the Actuary (OCACT) provides additional evidence that taxing the rich, by itself, won't save Social Security. Estimates from the OCACT show that taxing all earned income and doing nothing else (i.e., implementing none of Biden's other proposed changes) would only improve the solvency of the program's asset reserves by "about 35 years."
The final dilemma for President Biden is that he'll find inadequate support for his proposal in the upper house of Congress. Amending Social Security laws requires 60 votes in the Senate, and neither party has held a supermajority of at least 60 seats since 1979. It means all amendments to Social Security will require bipartisan cooperation, which is not something the president is going to get from his opposition when it comes to focusing taxation solely on the rich.
While it's possible that increasing payroll taxation on the rich is part of the solution that ultimately shores up Social Security, it's not a fix that, by itself, will resolve Social Security's shortcomings.
