Changing Social Security Financing

January 16, 2020 Aaron Helmbrecht

Changing Social Security Financing

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In 2019, 89 percent of Social Security’s funding came from payroll taxes on workers’ earnings. Employees and employers each pay a tax of 6.2 percent of an employee’s wages (Federal Insurance Contributions Act [FICA] tax), while self-employed workers pay the entire 12.4 percent (Self-Employment Contributions Act [SECA] tax). The rest of the program’s income comes from taxes on Social Security benefits and investment earnings of the trust fund. Payroll taxes are not assessed on income above the Maximum Taxable Wage Base ($137,700 in 2020) and do not apply to investment and other non-wage income.

Questions to consider:

  • Do the candidates have a reform proposal that includes changing the financing of Social Security?
  • Do the candidates have a comprehensive Social Security plan?
  • Do the candidates have proposals to change Social Security’s benefits?

Should the Payroll Tax Rate Be Increased?

Social Security projections would show solvency over the next 75 years by immediately increasing the tax rate by a total of 3.14 percentage points (1.57 percentage points each on the employee and the employer). Few are suggesting this full and immediate course of action because it would place a large burden on employers and workers, especially those earning less than the taxable maximum wage base. Gradual, small increases in payroll taxes could increase Social Security’s income while reducing the burden on employees and employers.

Should the Limit on Taxable Earnings Be Raised?

Some experts support raising, or even eliminating, the taxable maximum wage base to increase Social Security revenue from just high earners. Advocates cite a disproportionate tax burden under the current law on lower-income workers, who pay an equal or higher portion of their total income to Social Security than wealthier taxpayers. Others point out that lower-income workers receive a higher proportion of benefits compared to the taxes they pay than do higher-income workers. Some oppose increasing burdens on any taxpayers regardless of income.

When the taxable maximum structure was most recently changed in 1983, it was set to cover 90 percent of earnings and to increase each year with increases in national average wages. Increases in income for top earners has outpaced wage increases for the rest of the population, resulting in more wages that are above the taxable maximum levels. This has lowered the percent of earnings covered down to approximately 83 percent. Proponents suggest that the ratio of taxable earnings to covered earnings should be increased over time until it is restored to 90 percent.

The Academy’s Social Security Game

Explore options for Social Security reform and how changes will affect younger workers, retirees, and the program’s long-term health.

Should the Taxpayer Base Be Expanded?

Some state and local employees do not pay Social Security taxes because they are covered by a public retirement system that is considered comparable to Social Security. Requiring these workers to pay into Social Security (and later collect benefits) would add revenues to the program now, thus helping Social Security’s income in the near term. (It would reduce the long-term deficit because some of the benefits are not included in the deficit calculation as they are payable outside the 75-year window.)

Should the Trust Fund Assets Be Invested Elsewhere?

Social Security’s trust fund assets are invested almost entirely in non-marketable, special-issue U.S. government securities that represent loans to the U.S. Treasury’s general fund. The bonds pay market rates of interest. Some have advocated that greater returns could be achieved, on average, in the stock and bond markets. Others argue that Treasury investments are the safest available, and that Social Security is not the right vehicle for taking the risks inherent in the markets.

Should General Revenues Be Raised?

Social insurance programs in many other countries receive some financing from general taxes, and that approach could help with Social Security’s solvency challenge. Such an undertaking would require raising income taxes or raising revenues elsewhere, such as creating a national value-added tax or by taxing other sources of income (such as investment income). However, it has been argued that such proposals could compromise Social Security’s basic principle as a self-supporting program that is financed by its participants.

Should Individual Accounts Be Created?

Some reform proposals would allow workers to accumulate contributions in individual accounts under Social Security as a source of retirement income. Supporters say workers could exert more control over their accounts, obtain better returns on their contributions, and reduce the burden to future generations. However, the establishment of individual accounts as an add-on to Social Security would not by itself address the program’s financial problems.

Summary

From its inception, Social Security has had elements of individual equity and social adequacy. Individual equity means basing a worker’s benefit on their wage history. Social adequacy means basing a worker’s benefit on their deemed financial need. Both of these are essential to the success of Social Security by ensuring public support and an adequate level of income for covered workers. Any proposals to put Social Security on a sustainable financial footing should address which various financing mechanisms are to be part of the solution. All of the options have differing impact on individual workers as well as different levels of revenue to be raised. These trade-offs need to be evaluated in light of the Social Security system’s dual goals of individual equity and social adequacy.

COVID-19 Implications

The 2020 Social Security Trustees Report does not reflect the COVID-19 pandemic and states that the magnitude of near-term and long-range effects on the population and economy is unclear. For example, payroll tax revenues will decline in 2020, which will have a detrimental impact on Social Security financial projections and would likely change some of the numbers in this guide. Such potential effects of the pandemic illustrate a need to consider Social Security reforms in the near term so that a wider range of options that might provide a more gradual approach to benefit or revenue changes can be considered.

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