The biggest increase to Social Security checks since 1981 was good news for retirees. But it also served as a stark reminder that the program is expensive, with cuts to the benefits looming unless it is retooled in coming years.
Alongside news of the benefit increase last week was a tax hike for many Americans, with the wages subject to the Social Security payroll tax set to rise almost 9% next year.
Even before the cost-of-living increase was announced, Social Security’s trust fund was set to run out of reserves by 2035 if no changes are made. Historically, reforms to Social Security don’t make many people happy. So it’s worth asking: Does the program really need reform, and if it does, what changes are likely?
Where Things Stand
Social Security is a “pay as you go” system, with revenues collected today funding today’s benefits. Payroll taxes of 12.4%—with employees and employers each paying half that, and self-employed workers covering the full amount—finance about 90% of benefits.
Demographic trends mean that revenue stream is at risk, however, as the number of retirees grows faster than the number of workers paying taxes. In 2000, there were 3.4 workers for every Social Security beneficiary. The program’s actuaries project that will drop to 2.4 workers by 2030.
“That means we have to raise more from each worker or pay less to each beneficiary, or do a little of both,” said Richard Johnson, a retirement expert at the Urban Institute.
A much smaller slice of income comes from taxes paid on Social Security benefits, which were first introduced as part of a package of reforms in 1983. About 40% of beneficiaries pay taxes on part of their benefits, according to Social Security’s website.
Increase Payroll Taxes
The projected Social Security shortfall is equal to about 3.4% of taxable payrolls. If the payroll tax rate rose by 1.7 percentage points for employees and employers, that would enable everyone to get full benefits for the next 75 years, according to Alicia Munnell, director of the Center for Retirement Research at Boston College.
In 2023, the maximum amount of wages that incur Social Security’s payroll tax will rise to $160,200 from $147,000. A proposal from Rep. John Larson (D., Conn.), who chairs the Social Security subcommittee on the House Ways and Means Committee, would have a payroll tax kick in again starting at earnings of $400,000, while also creating a minimum benefit set at 25% above the poverty line. (Currently, benefits are based on your 35 highest-earning years and there is no minimum.)
Increasing the taxable base would raise revenues, especially if those payments didn’t accrue additional benefits. But “if it became a really bad deal for higher income people, I worry there would be less support for the program,” said Johnson. “What you get out has always depended on what you put in, and if policymakers break that link and Social Security is viewed as welfare, you might see support erode.”