Wage indexing vs. price indexing
In creating AIME, a worker’s past wages are indexed to bring them to the same level as today’s earnings.However, there are two possible ways that these past earnings could be indexed.
Price indexing is based upon the Consumer Price Index (CPI), and eliminates the effects of inflation.The result is to bring all wage amounts to a constant purchasing power.In this case, if inflation had increased by 5 percent since last year, simply multiplying last year’s wages by 1.05 would result in the amount necessary to be able to buy the same amount of goods as last year.
Wage indexing is based on the growth in average wages, and is supposed to allow workers to have roughly the same standard of living.The growth in average wages includes both inflation and growth in the overall economy.Under most circumstances, wage indexing should result in a higher AIME than price indexing.Social Security uses wage indexing only when calculating AIME.Once an initial monthly benefit has been determined, it is price indexed from then on to protect retirees from inflation.
The difference between the two forms of indexing can be very important.If a worker had been a bricklayer throughout his or her career, and earned $4.00 an hour in 1980, indexing that amount for inflation (an increase of 86.9 percent) would result in an indexed wage of $7.48 an hour.On the other hand, indexing that $4.00 an hour in 1980 for average growth in wages (an increase of 157 percent) would result in $10.28 an hour.While it is true that $7.48 in 2002 would buy the same amount as $4.00 in 1980 would, it may well be that the average wage for a bricklayer in 2002 has increased to something closer the $10.28 an hour figure.
Wage indexing allows retirees to take advantage of the increase in the standard of living over their working careers.However, it is often criticized as giving workers a retroactive credit for improvements in the economy.In other words, his or her 1980 wages are being measured according to the economy of 2002, rather than being a measure of the 1980 economy when they were actually earned.The key difference is in the consideration of replacement rates (see below under section VII).
Using bend points to come up with a benefit amount
Once an AIME has been calculated, SSA calculates a worker’s monthly retirement benefit using a formula that pays a higher benefit relative to income to lower income workers than it does to those who have earned more.In 2002, Social Security will pay an amount equal to 90 percent of the first $592 of a worker’s AIME.Then, it pays 32 percent of the AIME amount over $592 through $3,567, and 15 percent of any AIME amount over $3,567.The income divisions in this formula are called “bend points.”Bend points are adjusted each year.
To repeat the example above, if a worker had an AIME equal to $4,000, he or she would receive about 90 percent of first $590 ($531), 32 percent of the amount between $590 and $3,567 ($953), and 15 percent of the amount between $3,567 and $4,000 ($65).Thus the monthly benefit would be $1,549, or about 39 percent of his or her AIME.On the other hand, if the worker’s AIME had been only $1,200, he or she would have received 90 percent of the first $590 ($531) and 32 percent of the amount between $590 and $1,200 ($195) for a total monthly benefit of $726.However, this amount would be equal to 61 percent of AIME.
Annual COLA increases
Monthly benefits are increased by the every year by the amount of inflation.This is known as the Cost of Living Adjustment (COLA), and it is intended to preserve the purchasing power of a recipient’s benefits.The amount of the annual increase is announced each October although the change does not take effect until January 1 of the following year.It is based on the change from the third quarter in the year before the announcement is made through the third quarter in the year of the announcement.SSA currently uses the Department of Labor’s Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to measure inflation, but under some circumstances, it could use the annual increase in average wages instead.
As an example, on October 19, 2001, SSA announced a COLA increase of 2.6 percent for all checks issued after January 1, 2002.The increase was based on the change in CPI-W from the third quarter of 2000 through the third quarter of 2001.
The Retirement Earnings Limit: Working while receiving retirement benefits
Until a couple years ago, any worker under the age of 70 who received Social Security retirement benefits and chose to return to work would lose a substantial portion of his or her Social Security benefits.However, Congress has eliminated this penalty for workers who have reached their full retirement age.Workers between the age of 62 and full retirement age do face the likelihood of losing most of their benefits if they continue to work.
In 2002, workers under full retirement age can earn up to $11,280 without any consequences.However, for every two dollars they earn over that amount, their Social Security benefits will be reduced by one dollar.Rather than just reducing each month’s benefits equally, Social Security simply does not pay any benefits at all until the amount of the reduction is reached.Thus if benefits were to be reduced by a total annual amount of $4,500 and the monthly benefit was $1,000 a month, the worker would receive no Social Security check at all for January through April and half a check ($500) for May.Starting in June, the worker would again receive $1,000 a month through December.
The Government Pension Offset: what it is and how it works
Government Pension Offset affects the spouses of workers who held jobs that were not covered by Social Security.Most of these workers were either state and local government employees or joined the federal government prior to 1984. Spouses of Social Security recipients also qualify for a benefit equal to 50 percent of the worker’s benefit. However, the dual entitlement rule (see below) reduces that benefit dollar for dollar by any Social Security benefits that the spouse qualifies for under his or her own earnings record.
Since government workers who were not covered by Social Security do not have any of their own Social Security benefits, theoretically, they would qualify to receive the full spousal benefit.Thus, a person who joined the federal government prior to 1984 would be able to receive both his full Civil Service Retirement System (CSRS) pension and a Social Security spousal benefit equal.In order to eliminate this dual benefit, Congress created the Government Pension Offset in 1977.
Under this rule, 2/3rds of the CSRS pension would be treated as though it were a Social Security benefit, and the spousal benefit that worker could receive is reduced dollar for dollar by that amount.Thus, if the CSRS worker had a $1200 a month pension, $800 of his or her CSRS pension (2/3) would be treated as coming from Social Security. If that worker’s spouse also received $1200 a month from Social Security, that worker would also be eligible for a Social Security spousal benefit of $600 (1/2 the spouses basic retirement benefit).However, it would be eliminated because the portion of the CSRS pension that is treated as coming from Social Security under Government Pension Offset is larger ($800) than the potential spousal benefit ($600).
As a result of the Government Pension Offset, the CSRS worker and his or her spouse have received the same treatment as if both of them were covered by Social Security.Government Pension Offset affects about 300,000 retirees, and reduces Social Security’s aggregate benefits by approximately $1 billion annually.While a major proportion are retired federal workers, most of the rest were employed by state and local governments which chose not to participate in the Social Security program.The vast majority of these workers come from eight states: Alaska, California, Colorado, Louisiana, Maine, Massachusetts, Nevada and Ohio.
The Windfall Elimination Provision: what it is and how it works
The Windfall Elimination Provision is similar to Government Pension Offset, except that it applies to the worker’s benefits instead of his or her spouse’s benefits.It only applies to workers who have both a Social Security retirement benefit and a pension from a job that was not covered under Social Security, usually from a state or local government.It also applies to federal workers who were covered by the old Civil Service Retirement System instead of today’s Federal Employees Retirement System.
Under the Windfall Elimination Provision, the first bend point (see above) in the formula used to calculate a worker’s monthly benefit is reduced from replacing 90 percent of the first $590 (in 2002) of Average Indexed Monthly Earnings (AIME – see above for a discussion of what this is) is reduced to replacing 40 percent of that amount.This in turn lowers the affected worker’s monthly benefit.As an example, a worker with an AIME of $1200 would see his or her monthly benefit reduced from $726 to $431, while a worker with an AIME of $4,000 would receive $1,254 instead of $1,549.
There are exceptions to this provision depending on how long the worker was employed in a job covered by Social Security.The longer a worker was employed in a job covered by Social Security, the lower the benefit reduction.If the worker received “substantial” earnings for 30 years or more, there is no reduction in his or her Social Security benefit at all, while receiving that level of earnings between 21 and 29 years results in the 90 percent replacement bend point being reduced to between 45 percent and 85 percent.
The Windfall Elimination Provision adjusts the benefit formula to reflect the fact that the affected worker has in fact a much higher income than are reflected in his or her Social Security earnings.It was created because the basic Social Security benefit formula is designed to give lower income workers more for their Social Security taxes than higher income workers.As discussed above, the assumption was that lower income workers would be less likely to have income from a private pension or savings.If a government worker spent 30 years in a job not covered by Social Security, and only 12 years in one that is covered, his or her Social Security earnings record (AIME) would appear to be very low when compared to his or her actual average income including both jobs.This is because all of the non-Social Security covered income would be excluded.As a result, he or she would receive a low-income worker’s Social Security benefit despite the fact that he or she most probably is a middle or even upper income worker.
The dual entitlement rule
It has long been a principle of Social Security that a worker cannot qualify for full benefits under both his or her earnings record and that of a spouse.Accordingly, although a married worker theoretically qualifies for both retirement benefits from his or her own earnings record and a spousal benefit equal to 50 percent of the spouse’s retirement benefit, this situation comes under the dual entitlement rule.
The dual entitlement rule reduces the spousal benefit dollar for dollar by the amount of the retirement benefits the worker qualifies for under his or her own earnings record.Thus, if two spouses each qualify for $1200 a month from their own earnings record, and a spousal benefit of $600 a month (1/2 the basic retirement benefit), they would still only receive a total benefit of $1200.The $600 spousal benefit is eliminated because it is less than their earned retirement benefit.
On the other hand, if one spouse received $1200 a month and the other $400 a month from Social Security, the lower earning spouse would also qualify for a $200 spousal benefit.In that case, the $600 spousal benefit from the higher earning spouse would be reduced by the lower earning spouse’s benefit ($600-$400), leaving a $200 spousal benefit.The dual entitlement rule potentially affects 96 percent of the work force.
Notch Babies: how and why it happened
“Notch babies” are certain workers who were born between 1917 and 1921.Due to a technical error in a 1972 law, they receive slightly lower benefits than workers born before them, although they also receive slightly higher benefits than workers born after them receive.As a result, legislation has regularly been introduced in Congress that would either raise their benefits or provide them with a lump-sum payment.However, a 1994 commission found that although they do receive slightly lower benefits than workers born before them, notch babies receive a fair return for their taxes.As a result, no legislation concerning notch babies has been considered, and this situation is unlikely to change.
Notch babies get their name from a line graph showing average benefits by age of birth.Because those born between 1917 and 1921 tend to receive slightly lower benefits than those born before, the line has a slight notch for those years.The problem was caused in 1972, when benefits were first indexed for inflation.Unfortunately, Congress made a technical error in the law that resulted in workers receiving double adjustment for inflation.By the time that Congress corrected this error in 1977, some workers had already retired with higher benefits than they should have received, and rather than lowering their benefits, Congress decided to correct the problem only for those who had not yet retired.In addition, rather than just correcting the law to lower benefits to where they should have been, Congress phased in the change over a five-year period.The phase-in affected workers born in 1917 to 1921, and created the notch.
How survivors benefits are calculated
Survivors benefits depend on the earnings history of the worker who died.The same formula that calculates retirement benefits is also used for survivors benefits. They are usually calculated as a percentage of the benefit that a worker would have been eligible for at the time of his or her death.In general, they can be received by a spouse and by any children under the age of 18.
Surviving spouses at or near retirement age receive a benefit that is based on the worker’s retirement benefit.If the worker began to receive benefits at his full retirement benefits age, the surviving spouse will receive an amount equal to 100 percent of the worker’s benefits.This is also true if the worker died before beginning to receive Social Security.However, if the surviving spouse is also entitled to receive benefits, he or she will only receive the larger of the two amounts.The survivor will not receive both the worker’s benefit and his or her own benefit.
Where the worker decided to begin to receive benefits before he or she reached full retirement ages, such as at age 62, the survivor will also receive a reduced monthly benefit.The exact amount depends on the survivor’s age and the level of the worker’s benefit.As of 2002, a surviving spouse could receive benefits as young as age 60, but in that case would only receive 71.5 percent of the worker’s full retirement age benefit.This percentage will change every year as the retirement age increases.
In addition to the monthly benefit, surviving spouses receive a one-time $255 death benefit.This benefit is only payable to spouses or children eligible to receive benefits.
Another situation occurs if the worker dies leaving children under the age of 18.In that case, both the child and the surviving spouse are eligible to receive a benefit equal to 75 percent of the retirement benefit the worker was qualified to receive at the time of death.Both children and the spouse continue to receive this benefit until the last child reaches age 18.Benefits are also payable up to age 19 if the child is in high school at that date or age 22 if the child is disabled.The total amount that the family can receive is between 150 percent and 188 percent of the worker’s full retirement benefit amount.
How disability benefits are calculated
Currently, disability benefits are calculated using the same formula that is used to calculate retirement benefits.However, a worker who is disabled before he or she has worked 35 years will have disability benefits that are calculated using a shorter work history, and will not be penalized for not having worked as long.
It is not easy to be approved for Social Security disability benefits.The agency’s definition of disability is very strict, and often half of those workers who apply for benefits are turned down.Some of those workers who are rejected will be approved on appeal, but the process can be long and complicated.
To be eligible, a worker must be unable to do any kind of substantial work because of physical or mental disabilities, which are expected either to last at least 12 months, or to end in death.Just because a worker is unable to do the job he or she held before the disability does not automatically qualify them for disability benefits.Depending on their age, experience and education, they may be regarded as qualified to do other work, even if it is for a lower salary, and denied disability benefits.Family members may also be eligible to receive benefits because of a worker’s disability.
What (if anything) is Wrong With Social Security?
Americans have come to realize that Social Security faces serious financial problems that are only going to get worse. This public concern is well grounded. Studies and official reports confirm that Social Security is approaching a major financial crisis, and even if its revenue and expenditures were in long-term balance, the program is providing poorer and poorer retirement income security for the money Americans contribute. Younger workers are especially aware that Social Security will not be able to provide the benefits they have been promised when they retire.Below is a discussion of the two major problems facing Social Security.
How Social Security helped earlier generations
When President Franklin Roosevelt launched Social Security during the Depression, he and Congress considered it to be only one element--although a crucial element--of a three-part system that would provide a secure retirement for Americans. Social Security was to be a modest social insurance program designed to make sure that all Americans could count on a good basic pension. In addition, Roosevelt expected that retired workers would rely also on personal savings and private pensions supplied by employers.
The results were very good.Poverty among senior citizens is much lower than it was in the past, and much of the credit goes to Social Security.Workers born before 1935 earned a very high rate of return on their payroll taxes.For instance, according to GAO, the difference between what a worker born in about 1920 paid in Social Security taxes and received in benefits was the same as if he or she had invested them in stocks – about 7 percent a year after inflation.Unfortunately, younger workers will not benefit from Social Security as their parents and grandparents did.
Social Security’s two problems
While polls show that most workers have some idea of the financial problems facing Social Security that is only half of the picture.In addition, younger workers will receive much less for their taxes than older workers did.On top of that, Social Security taxes are now so high that they make it much harder for lower income workers to save money outside of the system.
Problem I – the impending financial crisis
For a host of reasons--ranging from demographics to the way that the program was designed--Social Security faces a financial crisis. The gap between what Social Security has promised to pay and what it expects to collect is staggering--and growing.Once the baby-boom generation begins to retire, barely a decade from now, today's small surpluses will quickly become larger and larger deficits. In 2016, the Social Security trust funds are expected to start paying out more in annual benefits than the system collects in payroll and income taxes. The SSA says that once those deficits begin, they will continue to grow larger and never end.There are a number of reasons for this impending crisis:
Fewer workers per retiree:In 1950, 16 workers supported each Social Security recipient. Now there are barely three workers per recipient, and by 2030 the ratio will fall to two per beneficiary.
People live longer:In 1935, the average 65-year-old was expected to live about 12.6 more years. Today, people who reach age 65 are expected to live more than 17 additional years. And by 2040, they will be expected to live at least 19 more years.
More workers take early retirement:The trend toward early retirement undermines Social Security. As recently as 1960, 77 percent of people in their early sixties remained in the workforce. Today, that number has dropped to 55 percent. Instead of continuing to pay into the system, early retirees become a burden on those who still work.
If Congress does nothing, annual cash flow deficits are predicted to begin in 2017. In inflation-adjusted 2001 dollars, the annual deficits are estimated to reach about $72 billion in 2020, $275 billion in 2030, $429 billion in 2050, and $719 billion in 2070. It appears that the annual deficits would continue and grow in size for as long as they could be projected.
The 75-year projection will continue to get worse because, with each passing year, a surplus year is lost on the front end and a deficit year is added on the back end. Over the period ending in 2077, Social Security's unfunded liability--the total amount that it has to pay over and above the amount that it will receive in future taxes--is about $25 trillion.
2017 or 2041?
Opponents of reform often claim that Social Security will not face any financing problems until 2041, when its trust fund runs out of assets.The alternative is 2017, when the program will begin to pay out more in benefits than the amount of taxes that it takes in. SSA estimates that it will take between $5.5 trillion in 2002 dollars to repay the trust fund.
As Section IV shows, the bonds in the trust fund can only be repaid through higher taxes, lowered benefits, reduced government spending on other programs, or borrowing. Once the trust fund has been repaid, the law requires Social Security to cut benefits by the same amount as its annual operating deficit.By waiting until 2041, taxpayers will have nothing to show for the $5.5 trillion that must be used to repay the trust fund.Facing a huge annual operating deficit, they will have few options other than reducing benefits or increasing taxes.
Problem II - rates of return
In addition to Social Security’s impending financial problems, the program faces another problem that will be much harder to solve.Social Security is an extremely poor investment when one compares the amount of retirement taxes a worker pays over a career to the amount of retirement benefits that the worker will receive. It is especially bad for younger workers. A worker could earn a much higher retirement income by investing his or her taxes in government bonds or a portfolio of investments such as stock index funds.
Comparing the total amount of Social Security retirement taxes paid over a working lifetime by a 30-year-old, two-earner couple who make average incomes (about $29,000 a year each) with the amount they will receive in benefits shows that they will earn the equivalent of only 1.23 percent (after inflation) a year. Over their lifetime, together they will pay a total of about $320,000 in Social Security retirement taxes (including both the employer and employee shares) and can expect to receive about $450,000 in total retirement benefits.
If this same couple had been allowed to invest the same amount they paid in Social Security retirement taxes in a conservative portfolio of 50 percent super-safe U.S. Treasury bonds and 50 percent stock index funds, they could expect to have $975,000 at the time they retired--$525,000 more than they would get from Social Security. This equals a rate of return of 5 percent a year, which is over four times higher than they would get from Social Security.
Rates of return are much worse for younger families. For instance, a married couple with two children and a single earner who was born in 1932 do fairly well, receiving 4.74 percent on their retirement taxes. However, the same type of family in which the earner was born in 1976 will receive less than 2.6 percent. Families with earners born after 1976 will receive even less.
Single males do especially badly. An average-earning single male born after 1966 can expect to receive a rate of return after inflation of less than one-half of 1 percent on the Social Security retirement taxes that he pays.
To make matters worse, if a worker dies before retirement, all of the Social Security taxes that he or she paid throughout the years will be lost unless the worker leaves either young children or a spouse who qualifies for lower benefits. All that this worker receives from the thousands of dollars that he or she paid over a lifetime of work is a single $255 death benefit.
African-Americans are especially hurt by low rates of return
Although Social Security is structured to pay higher benefits to workers with lower incomes, low-income African-American males may actually pay more in Social Security taxes than they will get in benefits, even under the most favorable assumptions. Again, the younger the worker is the lower the rate of return. For example:
A single, low-income, African-American male born after 1959 loses money in Social Security. For instance, a single African-American male in his mid-20s who earns about $13,000 a year would get only about 88 cents in retirement benefits for every dollar that he pays in taxes. This equals a lifetime loss of about $13,400. If he had been allowed to invest his Social Security retirement taxes in a portfolio of 50 percent government bonds and 50 percent stock equity funds, he would not only have not lost money, he would have accumulated over $145,000 more at the time he retired.
A 21-year-old African-American single mother who makes about $20,000 per year (the current average income for African-American females) can expect to receive a rate of return from Social Security of only 1.2 percent. Even just investing the amount of Social Security retirement taxes that she and her employer pay in U.S. government bonds would earn her around 3 percent. This translates into $93,000 more for retirement than she would get from Social Security. On the other hand, investing her Social Security retirement taxes in a portfolio of 50 percent government bonds and 50 percent stock index funds would earn her almost $383,000 for retirement (before taxes)--$192,000 more than she would get from Social Security.
Because of their lower life expectancy, African-Americans are hit especially hard by the inability to include Social Security retirement taxes in their estates. Except in situations where the worker leaves young children or a spouse with lower benefits, this money permanently leaves the community and benefits others with longer life spans.
Workers have no legal right to Social Security benefits
According to the Supreme Court, workers actually neither own nor have a legal right to their Social Security benefits.In fact, the Court has even said that Congress can end Social Security benefits at any time. In 1960, the Supreme Court ruled in Flemming v. Nestor that Americans have no property right to their Social Security benefits. In his dissent, Justice Hugo Black observed that this decision "simply tell[s] the contributors to this insurance fund that despite their own and their employers' payments the Government, in paying the beneficiaries out of the fund, is merely giving them something for nothing, and can stop doing so when it pleases."
Today's Social Security taxes crowd out other savings
Approximately 75 percent of American workers pay more in Social Security taxes than they do in income taxes. Over the past few decades, both the Social Security tax rate and the amount of income subject to the tax have increased dramatically. Specifically:
Over the past 50 years, the Social Security payroll tax rate has climbed from 2 percent (one percent by the employee and one percent in his or her behalf by the employer) to 12.4 percent (6.2 percent by each). The retirement portion of Social Security accounts for 10.6 percent of the payroll taxes.
As recently as 1971, the tax applied only to the first $7,800 of income. As of January 1, 2002, this tax is collected on all income up to $84,900.
The combination of higher rates and greater amounts of income subject to the tax has caused the maximum Social Security payroll tax to climb from $60 in 1949 to more than $10,500 today.
As Social Security taxes have risen, Americans have had fewer dollars left over for other types of saving. The average family now spends as much for Social Security taxes as they do for housing, and nearly three times more than they do for annual health care expenses. Because of rising payroll taxes for retirement, more poor and middle-income workers do not have the after-tax funds needed for other savings.
Approaches to reform
With the formidable problems (see above) facing the Social Security program, simply doing nothing is not an option.If Social Security is to be available to future generations, something must be done – and soon.With every passing year, the time when Social Security will run surpluses becomes shorter.And, once the program begins to run deficits, SSA predicts that they will not end for as far in the future as they can forecast.
How can Social Security be fixed?
There are only three ways to cure Social Security’s problems.To do this correctly, the cure has to both resolve the program’s financial problems and raise younger workers’ rates of return.The simplest way to fix Social Security is to either raise taxes and/or reduce benefits.These measures take care of the coming financial crisis.Unfortunately, they also make rates or return even worse than they are today.Essentially, one is paying more, getting less, or both.
The only other alternative is to make payroll taxes work harder by allowing workers to invest all or a part of them in stocks or bonds through personal retirement accounts (PRAs).Since stocks and bonds give workers a much higher rate of return than the current form of Social Security can offer, PRAs can both improve retirement income and help to close the gap between what today’s Social Security promises and what it will be able to pay.The exact result depends on the amount of payroll taxes diverted into PRAs and how it can be invested.
Promised benefits vs. what Social Security can actually pay
In order to fairly understand the impact of Social Security reform, its benefits should be compared to what today’s Social Security can actually pay for under its current tax structure, and not just to what it promises to pay.While this is not a crucial distinction in the near term, it becomes extremely important in future years.
If nothing is done, today’s Social Security has the revenues to pay 100 percent of promised benefits through 2017.It also has a mechanism to collect enough additional non-Social Security taxes to pay full benefits through 2041.(For a discussion of how this works, see trust funds under Section III.) After that date, Social Security will only have enough resources to pay about 75 percent of promised benefits.Therefore, any comparison of benefits paid after 2041 should use what Social Security can actually afford to pay instead of what the program promises.
Comparing benefits payable under Social Security reform with what Social Security promises would be valid only if the discussion also included what specific steps would be taken to make up the funding shortage, and how much they would cost.
Why we can’t grow our way out of trouble
Some supporters of the current Social Security system assert that its problems can be solved by faster economic growth. Without much evidence, they claim that current economic projections are entirely too pessimistic and that the financial shortfall will disappear if the numbers are made more optimistic.
Robert Reich, former Secretary of Labor in the Clinton Administration, for example, has called the SSA economic projections "wildly pessimistic." Economist James K. Galbraith claims that if higher growth rates were substituted for the SSA's projected rates, "future deficits disappear without any cuts in benefits or increases in taxes."
Regrettably, claims that Social Security can be saved by faster economic growth are wrong. If anything, the projections underlying the Social Security Administration's forecasts are likely to be overly optimistic. And even if they are not, higher growth will have little impact on the system's solvency. By some measures, faster growth could even add to Social Security's problems.
If the inflation-adjusted growth rate of average wages over the next 75 years increases over the current forecast by 56 percent, then:
The date when Social Security will begin to spend more each year in benefits than it receives in payroll taxes would be pushed back by a mere two years.
Although economic growth would increase revenues, over the long run, benefits would grow even faster.This will cause the annual deficits to be substantially larger than they are currently predicted to be.
In short, critics of reform are mistaken if they think faster-than-predicted economic growth will help the Social Security system avoid its financial crisis. Without fundamental reform that allows workers to invest their own Social Security taxes, deep benefit cuts or steep tax increases will be required, regardless of how rapidly wages grow.
Raising payroll taxes
One way to eliminate Social Security’s impending financial problems would be to raise payroll taxes.The resulting extra revenue would allow the program to meet its obligations.However, while the increases could be as low as 3 percent of income through about 2020, as Social Security’s annual deficits grew, so would the tax increases necessary to fill the funding hole.As a result, by 2060, Social Security taxes would have to climb by over 50% to 19 percent of income.This figure does not include either income taxes or any taxes necessary to fund Medicare.
Social Security taxes already drive marginal rates above 40 percent for many taxpayers. A taxpayer in the 28 percent federal income tax bracket, for example, typically pays 5 percent in state income taxes and 15.3 percent in Social Security and Medicare taxes.An increase in payroll taxes would especially affect the self-employed, who pay both the employer and employee share of those taxes. Recent research indicates that a 5 percent increase in marginal tax rates leads to a 10.4 percent decrease in the probability of investment by those sole proprietors and that marginal tax rates that are high and progressive strongly discourage entry into self-employment and business ownership.
Eliminating the earnings cap on payroll taxes
Another way to increase payroll taxes without affecting lower income workers would be to raise or eliminate the taxable wage cap.Currently, workers only pay Social Security taxes on the first $84,900 that they earn.This cap increases each year.Those who support this step claim that it will raise enough additional revenue to greatly reduce the program’s coming financial crisis.
Based on SSA's own projections, however, eliminating the cap on wages subject to the OASI payroll tax would generate only enough revenue to delay the date of the system's insolvency by a few years. Moreover, by 2035, the OASI program would have enough revenue on hand to pay only 87 cents on every promised dollar in benefits.
The cost of this change would be substantial. Specifically, eliminating the cap on taxable wages would:
Result in the largest tax increase in the history of the United States to raise $505 billion (in nominal dollars) over five years and almost $1.2 trillion over 10 years.
