When politicians debate the best ways to preserve Social Security for future generations, their plans usually involve reducing benefits or increasing the age at which Americans can start receiving their Social Security checks. However, presidential hopeful Bernie Sanders has a different idea that he claims could boost retirees' Social Security income by an average of $780 per year. Given the importance of Social Security to millions of Americans, this plan deserves a close look.
Social Security is a pay-as-you-go system, and that means the money paid to current Social Security recipients comes largely from payroll taxes paid by current American workers. Employees and employers split the bill on a 12.4% payroll tax on earnings of up to a $118,500 per year. Any income above that is exempt from the payroll tax.
According to Sanders, that income cap is a big reason why Social Security could end up struggling to meet its obligations to retirees in the future.
The amount of money brought in through payroll taxes has fallen short of the amount of money paid out to Social Security recipients since 2010. To make up for the difference, the Social Security Administration is tapping the Social Security Trust Fund. Unfortunately, that trust fund will no longer be able to make up the difference between tax inflows and Social Security outflows beginning in 2030. Absent any changes, Social Security benefits could face an across-the-board reduction of 29% that year, according to the Congressional Budget Office.
In order to avoid such a cut to benefits, policymakers have discussed a slate of solutions that include increasing the full retirement age to 70, changing how annual Social Security benefit increases are calculated, and reducing payouts to high-income recipients.
Sanders, however, has a different idea. Rather than change ages, adjust formulas, or cut benefits, Sanders thinks a better plan is to boost tax revenue. Sanders would keep the current 12.4% rate in place, but he would change the income limit rules so that high-income earners contribute far more tax revenue to the Social Security system.
Specifically, Sanders' plan is to assess the 12.4% payroll tax on any income earned above $250,000 while leaving income between $118,500 and $250,000 tax-free.
For example, let's say you earn $1 million per year. Today, you and your employer would pay a combined 12.4% payroll tax on the first $118,500 of income and then pay nothing on the remaining $881,500. Under Sanders' plan, there would still be a 12.4% payroll tax on your first $118,500 of income, but there would also be a 12.4% payroll tax on your income between $250,000 and $1 million. Therefore taxes on your million-dollar income would climb from $14,694 to $107,694 per year.
Sanders estimates that this would dramatically extend Social Security's solvency. Rather than facing a cash crunch in less than 15 years, Social Security would supposedly stay in the black for the next 50 years.
Importantly, Sanders' 50-year figure is calculated after factoring in a $65 per-month, or $780 per-year, increase in the average monthly Social Security check.
Given that the average American will receive about $16,100 in Social Security income in 2016, that $780 represents a 4.8% raise.
Increasing the tax burden on high-income earners could result in unintended consequences, such as slower economic growth. And high-income earners will, understandably, recoil at the prospect of seeing so much more of their money head to Washington. Whether or not Sanders' plan would pass muster in Congress or accomplish what he says it will is anyone's guess, but given how many people rely on Social Security income in retirement, some form of tax increase may ultimately be more palatable to voters than other policies that could reduce monthly payments.