Social Security’s Insecurity

Under current rules, the Social Security Trust Fund is likely to be bankrupt by 2033, which means that benefits probably would be reduced thereafter by 25%.

Question 4. Ask the Candidate:

Why not fix much of Social Security’s long-term solvency problem by making Social Security taxes apply to higher levels of wages?

Social Security scheduled benefits probably can be paid through 2033 because Social Security taxes are supplemented by the Social Security trust fund. But the trust fund is then projected to be bankrupt. Thereafter, Social Security taxes could cover only about 75% of the benefits.  

This prospect is unlikely to distract most of today’s card-carrying seniors, who figure they’ll be beyond fretting about such worldly matters in 23 years. But it surely should distress the 20- 30- 40-something crowd. They could be severely short-changed unless Congress reforms the program. There are many sensible ways to do this.

Here’s one major, fixable funding problem. The Social Security tax now applies to wages up to $110,100--the bottom 83% of all wages. When Social Security last was reformed in 1983, the tax applied to the bottom 90% of all wages. Returning to this 90% formula could solve over 40% of the long-term shortfall.

The Countdown to An Entirely Avoidable Crisis

 All Social Security taxes are paid into the Social Security trust fund, which then pays Social Security benefits. The trust fund currently earns interest on its substantial surplus by lending it to the Treasury Department, which pays the interest from general tax revenues. But by 2033, Social Security outlays are expected to use up the entire surplus. Yes, the trust fund will be empty.[1] Benefits then will be paid solely from current Social Security taxes, which will be sufficient to pay only about 75% of expected benefits, unless Social Security is reformed.

Imagine how seniors would feel if their benefits were cut by 75% today. The average monthly benefit of a beneficiary this year is about $1,230. You wouldn’t want to be the one to tell her that next month she will receive only $925, particularly if she is among the 64% of those over 65 who receive half or more of their income from Social Security; worse, she might be among the 22% who receive all of their income from Social Security.[2]

If these figures don’t worry you, here’s another way to look at the long-term deficit problem. If, today, Congress wanted to deposit sufficient funds in the Social Security trust fund to meet projected obligations over the next 75 years, it would have to find, somewhere, a staggering $8.6 trillion.[3]

Social Security projections are only estimates, of course, not predictions. No one can know with certainty what the predicament of Social Security might be 23 years from now, let alone 75 years or longer.

Are these figures imagined by some modern Wizard of Oz just to scare us? Hardly. These estimates come from the Social Security Trustees, who include the Secretary of the Treasury, the Secretary of Health and Human Services, the Secretary of Labor, and the Commissioner of Social Security, not exactly wild and crazy types.

Danger signals based on predictable demographic changes have been flashing for decades. The number of beneficiaries will climb rapidly as the baby boom generation begins to retire this year. By 2030, about 20% of the population is expected to be 65 or over compared to about 13% today. Currently there are about 4.6 workers for every beneficiary (compared to 42 in 1945); by 2035, there will be only about 2.0 workers per beneficiary.[4] And seniors will live longer and longer.

“To extinguish a Debt which exists and to avoid contracting more are ideas almost always favored by public feeling and opinion; but to pay Taxes for the one or the other purpose, which are the only means of avoiding the evil, is always more or less unpopular.  These contradictions are in human nature.”  —Alexander Hamilton

The Wage Threshold: A Major Source of the Funding Crisis

Many people are unaware that Social Security taxes never have applied to all wage levels. From 1937 through 1949, the tax applied only to the first $3,000 of wages. Because the tax rate was 1%, no one ever paid more than $30 a year. That amount was matched by the employer—which always has been required under Social Security laws-- for a grand total of $60. Sothe combined contribution of employer and employee during the first 13 years of Social Security never exceeded $60.

Employers generally reduce an employee’s wages or fringe benefits by all or most of the employer’s matching Social Security tax, which means that the employee effectively pays all or most of the employer’s share as well as his own.

The wage threshold began to rise sharply after 1949. Since 1982, it has increased annually in proportion to increases in average annual wages. The tax rate also rose significantly over the years, reaching 6.20% for both employers and employees in 1990, for a total of 12.40%; and this is where it remains today.[5]

Social Security benefits have exceeded the value of the taxes beneficiaries paid who were born before about 1935. This has created long-term deficits for the program.

For 2012, the wage threshold is $110,100. So a worker can pay as much as $6,826 ($110,100 x 6.2%) a year in Social Security taxes, which, with his employer’s match, brings the total to $13,652. But no additional tax will be paid for wages above $110,100.

The existence of a wage threshold makes Social Security taxes regressive: They take a greater percentage of the wages of workers who earn up to the threshold than of the wages of workers who earn above the threshold.  For example, if you earn $40,000, you pay the full 6.2% tax on it; if you earn $400,000, you pay the full 6.2% on $110,100 ($6,826) but 0.0% on the next $289,900, for an average tax rate of only 1.7%.

The $6,826 Social Security tax is only 1.7% of $400,000 in wages.

Medicare and Social Security used to have identical wage thresholds. In 1990, however, Congress was sufficiently concerned about Medicare’s long-term solvency that it raised the Medicare wage threshold; and, in 1993, Congress eliminated it altogether. Since then, Medicare’s 1.45% tax has applied to all wages, even those of the highest-paid executives.       

To summarize, Social Security and Medicare taxes, totaling 7.65% (6.20% + 1.45%), apply to $110,100 of wages this year, but only the 1.45% Medicare tax applies to wages above $110,100. 

What Congress Should Do

Yikes, if I’m 78 or older, I’m guilty too!

To save Social Security for future generations, Congress must address its “long-term” projected deficits.  By “long term,” I am referring to the projected deficits over the next 75 years as estimated by Social Security actuaries.[6] According to Henry Aaron, a highly respected expert at the non-partisan Brookings Institute, “all of the projected funding gap facing Social Security Trust funds—and more—results from the payment of benefits to people who qualified for benefits early in the life of the program…All cohorts born before about 1935 received benefits worth more than the taxes they paid.”[7] The problem should have been addressed long ago, but we’re stuck with it. Still, if Congress acts promptly, the solutions need not be drastic.

The Major Reform: Raise the Wage Threshhold. The major reform should be raising the wage threshold which now covers only 83% of all wages. In fact, eliminating the wage threshold entirely (and paying benefits on these higher wages) could eliminate 95% of the Social Security deficit over the next 75 years.[8] But placing almost the entire burden for fixing Social Security on higher-income workers would be politically untenable, particularly because there are a range of other sensible reforms.  

The 90% wage threshold should be phased in over several years to allow businesses to plan for it.

An appropriate compromise would be to restore the threshold to cover 90% of all wages, as established in 1983 upon recommendations of the National Commission on Social Security Reform, headed by Alan Greenspan.[9] This single reform, which would raise the threshold somewhere above $170,000, with annual adjustments, would affect only about 6% of all workers. Yet it would eliminate over 40% of the long-range shortfall.[10] 

You’re perhaps wondering why this seemingly obvious option has not already been addressed by Congress. Perhaps you know the answer: Higher-income workers have strongly opposed it. They know that, under Social Security’s benefit structure, their additional tax payments would add relatively little to their total retirement payments compared to what they would expect to realize if they invested the extra taxes in private accounts. Here’s why.

Your Social Security retirement benefits are calculated as a percentage of your average annual wage during your highest 35 years of wages; for this purpose, wages in earlier years are adjusted to their value in the year of retirement. Different percentages—ranging from 90% to 32% to 15%--apply to different levels of average wages for calculating your benefit. If you retire in 2012 at normal retirement age, and if your average wage for 35 years is no more than $9,204, your benefit will be 90% of that amount, or a maximum of $8,284. If your average wage is higher, you will receive 90% of the first $9,204, plus 32% of the next $46,764; and if your average wage is even higher, you will receive 15% of the top portion. This 15% multiplier produces a very small return in exchange for the taxes paid on those higher levels of average wages, which is what concerns high-income earners.

In 2012, a low-income single beneficiary might receive only $8,000, while a high-income single beneficiary might receive over $25,000.

To summarize, the total annual benefits of high-income workers are (a) considerably larger than those of ordinary workers but (b) are a considerably smaller percentage of their average wages than are the benefits for low-income workers. High-income workers should be comforted somewhat in knowing that they have longer life expectancies, on average, than do other cohorts, which means they will receive Social Security benefits for more years than will other cohorts. Seniors who have lived in poverty have the shortest life expectancies.[11]

Three Other Reforms. Along with raising the wage threshold, Congress should adopt a variety of other reforms. Let me mention just three here.

1.  Add New State and Local Workers. Congress should move Social Security closer to universal coverage by including all new state and local workers. Today, over one-quarter of state and local government workers—nearly 7 million people—are not covered by Social Security because they participate in an alternative public pension plan. State and local workers are, on average, well paid and should share some of the responsibility to address Social Security’s financial problems. If Social Security included all future state and local employees, it would solve 8% - 9% of the deficit anticipated over the next 75 years.[12]

2. Deposit Estate Taxes in Social Security Trust Fund. Congress should designate all estate tax revenues for deposit in the Social Security trust fund. This may make the highly controversial extension of the estate tax more acceptable to those who oppose the tax. It definitely would help reduce the long-term Social Security deficit, perhaps by as much as 25%.[13]

3. Gradually Extend  Early and Normal Retirement Ages. Social Security benefit levels should take into account increases in life expectancies. The initial Social Security legislation in 1935 identified the “normal retirement age” when benefits would begin as 65, and there was no early retirement age. Most people worked into their late 60s or early 70s and had much shorter life expectancies.  

Today, to receive a comparable number of years of Social Security benefits, a worker would need to retire at 75. But the normal retirement age today is 66 (and will rise gradually to 67 by the year 2027). Moreover, the typical worker today take “early retirement” at 63 or 64 primarily because substantial benefits may be received beginning at age 62. That worker can be expected to draw benefits for at least 20 years.[14]

Extending workers’ ages for early retirement and full retirement benefits, however, would not, on average, reduce their lifetime benefits. All benefits are adjusted based on the age of retirement and life expectancy. This means that the present value of the total benefits you can expect to receive will be the same whether you retire at 67 or 70; your monthly benefits simply will be higher if you begin receiving them at 70 rather than 67.

Still, there could be many benefits from delaying normal and early retirement ages. Many workers who remained in the workforce longer could build larger private retirement accounts that eventually would supplement their Social Security benefits. Their longer participation in the workforce also would increase both payroll tax and income tax revenues. The cumulative effect, according to Andrew Biggs of the American Enterprise Institute, would be to “boost the gross domestic product over the long term “by around 5 percent, adding billions to the economy and tax revenues.”[15] Even if Biggs’s figures are high, the overall benefits should be significant.

Finally, any extension of the early retirement and normal retirement ages must address the difficulty many workers would have postponing their retirement. This would mean, for example, that Congress should examine the federal disability income program as well as the Supplemental Security Income program to make sure that workers who cannot extend their working days are adequately protected.

The Privatizing Option

This Question 4 cannot conclude without addressing proposals of others, including Presidential and Vice-Presidential candidates Mitt Romney and Paul Ryan, that offer younger workers the choice to opt out of Social Security into private investments they would control. Without knowing sufficient details about what Messrs. Romney/Ryan may have in mind, I will focus here only on the earlier efforts of George W. Bush.

Following his re-election in 2004, President Bush believed the time was ripe to capitalize on growing concerns that Social Security no longer was the preferred safety net for younger generations. He travelled around the country arguing that workers would be better off if they could allocate a portion of their Social Security taxes to private accounts. Workers then could invest these private accounts in the stock market, which historically has outperformed U.S. bonds--the exclusive investment of the Social Security trust fund.

Most Americans, however, rejected the idea of diminishing the promises of Social Security for the risks of the marketplace. As some policy experts have written, “Social insurance is part of the essential social glue that holds an individualistic polity together and that makes the economic risks of a market economy tolerable.”[16]

Specifically, critics of Mr. Bush’s failed initiative believed that the creation of some private accounts would be the first step toward privatizing all of Social Security, which they strongly opposed; that most workers would not have sufficient sophistication to know how to invest their funds; that the investments might not outperform and could under-perform U.S. bonds (as we saw when the stock market tumbled a few years later); that disabled beneficiaries would suffer badly under Bush’s plan; and that removing any significant share of Social Security taxes from the trust fund would require workers to pay significantly more Social Security taxes to satisfy obligations to existing and new beneficiaries.

Most unconvincing was Mr. Bush’s claim that his “plan is particularly good for low-income people, particularly low-income women” and would help “spread the idea of ownership beyond just the so-called ‘investor class.’”[17] The president’s plan, however, required a worker at retirement to convert her personal account into a lifetime annuity if withdrawing the funds in a lump sum “would result in [her] moving below the poverty line.”[18] That often would be true for a low-income worker.  A lifetime annuity would mean that her account would die with her, along with any notion that a private account was her ticket into the ownership society. Moreover, if she became disabled or died, Social Security would provide benefits to her or her young dependents, a crucial element of her safety net, but her private account would not.[19]

We know the debate remains alive and well. We can all agree that most workers have developed inadequate personal investment accounts and must be encouraged to save more. But, in my view, this should be outside the basic Social Security program.


So let’s ask the candidates: How would you fix Social Security’s long-term insecurity assuming it is not privatized? And do you agree that Congress should raise the wage threshold?

[1] The 2012 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds, GPO: Washington, D.C., April 25, 2012, 21, 75.

[2]  See Henry J. Aaron, “Social Security Reconsidered,” National Tax Journal, June 2011, 64 (2, Part 1), 385. Aaron’s figures are for 2008, but they are unlikely to be any better, given the economy, for 2012.

[3] Ibid, 4.

[4] Ibid, 53.

[5] The 6.2% combines the OASI tax (5.3%) and the Disability Income tax (.9%).

[6] Under current laws, a large deficit arises as well after the next 75 years, but we will not address those issues here.

[7]  See endnote 1, 386 – 397.

[8] Ibid.

[9] Thomas L. Hungerford, “Increasing the Social Security Payroll Tax Base: Options and Effects on Tax Burdens,” Congressional Research Service, April 9, 2010, 2.

[10]  Janemarie Mulvoy, “Social Security: Raising or Eliminating the Taxable Earnings Base, Congressional Research Service, September 24, 2010, 13, Summary. Aaron estimates that the 90% formula would cover only about one-third of the deficit. Ibid., at 410. If Congress ever converted the exclusion for employer-paid health insurance to an individual tax credit, as recommended in Question 5, then any employer-paid insurance would be part of taxable wages, which would increase substantially the base for Social Security taxes and greatly lengthen the life of the Social Security trust fund.

[11] Social Security’s progressive benefit formula remains sensible today because about 40% of all people who are 65 and older receive at least 90% of their income from Social Security. In other words, this bottom 40% has few other sources of income. By contrast, high-income workers usually have substantial pension benefits and other investment assets at retirement that contribute to comfortable retirement incomes. On the other hand, various studies, according to Henry Aaron, find that, because high earners live longer than low earners, “the present discounted life-time value of old-age pension benefits for high earners is as high as or even greater than those for low earners.” Aaron, ibid at 406.

[12] Dawn Nuschler, Alison M. Shelton, John J. Topoleski, “Social Security: Mandatory Coverage of New State and Local Government Employees,” Congressional Research Service, July 25, 2011, Summary.

[13] Chye-Ching Huang, “The High Cost of Estate Tax Repeal,” Center on Budget and Policy Priorities, January 28, 2009. The idea of devoting estate taxes to the Social Security trust fund was first proposed by Robert Ball, who served as Social Security Commissioner under Presidents Kennedy, Johnson, and Nixon. The estimated impact on long-term Social Security deficits was made in 2005 by Social Security actuaries based on rules expected to be in effect for 2009, when the estate tax exemption was scheduled to apply to taxable estates worth no more than $3.5 million, and the gift tax exemption was scheduled to apply to gifts up to $1 million. The exemption in 2012 is $5 million for estates and gifts. The estimate of potential estate taxes would vary depending, inter alia, upon what estate and gift tax exemptions are adopted by Congress after 2012.

[14]  See Andrew G. Biggs, “The Case for Raising Social Security’s Early Retirement Age,” American Enterprise Institute for Public Policy Research, No. 3, October 2010.

[15] Ibid.

[16] Marmor, Theodore R, and Jerry L. Mashaw, “Understanding Social Insurance: Fairness, Affordability, and the ‘Modernization’ of Social Security and Medicare,” Health Affairs, March 21, 2006, 1.

[17] See, for example, President Bush’s speech to employees of the Nissan North America manufacturing plant in Mississippi, May 3, 2005.

[18] President George W. Bush, State of the Union Address, February 2, 2005.

[19] Social Security pays disability benefits to more than 6 million disable workers, to 2 million children of retired and disabled workers, and to nearly 2 million children who are survivors of deceased workers. Social Security Advisory Board, “Social Security: Why Action Should be Taken Soon,” September 2005, introductory page.

© 2012 John O. Fox - All rights reserved. You may print, reproduce, and use the articles on this website for personal, educational or non-commercial purposes. Copying, redistribution, or use of any material on this site for commercial purposes is prohibited without the express written permission of the author.