Social Security’s Future: The Tax Change No One Wants to Discuss

⏱️ 14 min read             

There’s a critical two-word issue that impacts millions of Americans. Social Security. 

That sound you here is Congress kicking the tin can down the road as their solution.

The retirement program we all rely on is running out of time, and there’s a fix no one seems to want to talk about. So, hear me out: a small tax increase, just a fraction of a percent, could secure Social Security for decades to come. 

But there’s a catch – lawmakers would have to act. Why is such a simple solution being ignored? And what does it mean for your future? 

Welcome to That's Life, I Swear.  This podcast is about life's happenings in this world that conjure up such words as intriguing, frightening, life-changing, inspiring, and more. I'm Rick Barron your host. 

That said, here's the rest of this story 

The future of Social Security is a hot-button issue for many Americans, with widespread concern about the program's long-term viability. A common misconception, particularly among younger generations, is that the system will be defunct by the time they reach retirement age. This belief, however, may be unfounded.

Political figures often tiptoe around this complex topic, given its sensitive nature. Recent projections from the Social Security Trust Funds report suggest that without intervention, beneficiaries could face a 20% reduction in payments starting in 2033.

However, upon closer examination, the solution to this seemingly insurmountable problem appears more manageable than initially thought. This assertion isn't speculative; it's grounded in data analyzed by Alicia Munnell, a renowned Social Security expert and economics professor at Boston College.

In a recent discussion, Professor Munnell proposed a straightforward fix: an increase of 3.5 percentage points to the current 12.4% Social Security payroll tax, split evenly between employers and employees. This adjustment, she argues, would be sufficient to maintain full benefit payments well into the 2030s and beyond.

Munnell also emphasized an often-overlooked fact: even in the absence of any congressional action, beneficiaries would still receive a significant portion of their promised benefits. This is because the majority of Social Security funding comes from ongoing payroll taxes paid by the current workforce, rather than solely relying on the diminishing trust funds. If the trust funds were to be depleted entirely, payroll taxes alone would still cover approximately 80% of promised benefits.

Despite these reassuring figures, Professor Munnell remains optimistic that such a scenario is unlikely to unfold, suggesting that a resolution to ensure the program's longevity is within reach.

The Inevitable Evolution of Social Security

The political landscape surrounding Social Security reform is complex, but change seems inevitable. Historical precedent suggests that benefits for current or soon-to-be retirees are unlikely to face cuts. The voting power of older Americans acts as a safeguard against such measures, as evidenced by the swift reversal of the Reagan administration's proposed benefit reductions in the 1980s.

While the current political climate may not be conducive to immediate action, the looming threat of benefit cuts in the next decade will eventually force policymakers to address the issue. Professor Munnell emphasizes that maintaining, rather than reducing, Social Security benefits is critical for the financial well-being of both current and future retirees, given the shortcomings in other aspects of the nation's retirement system.

Party views to deal with Social Security. Courtesy of Pew Research Center

However, the solution - a tax increase - remains a politically charged topic. Politicians, while pledging to preserve Social Security, have yet to openly discuss specific reform measures. This reluctance is understandable in an election year, as proposing tax hikes, even modest ones, for a problem that won't manifest fully for years is politically risky.

Professor Munnell highlights the challenge: and I quote: "Convincing people to accept higher taxes now for benefits they believe they're already entitled to is a tough sell. Historically, our country tends to delay action until we're at the brink of crisis. We saw this pattern in 1983 with the last major Social Security overhaul." End quote

The professor's concerns reflect a broader pattern in American politics - the tendency to postpone difficult decisions until they become unavoidable. This approach, while politically expedient in the short term, often leads to more drastic measures when the problem can no longer be ignored.

Demystifying Social Security: A Veteran's Perspective

With over six decades of experience in Social Security research, Professor Munnell, now 81, brings a wealth of knowledge to the table. Her credentials include a position as assistant secretary of the Treasury for policy issues in the mid-1990s and a 26-year tenure leading the Center for Retirement Research at Boston College. Her annual reports, published shortly after the official Social Security trustees' releases, are known for their clarity and insight.

Despite her deep understanding of Social Security's intricacies, Munnell advocates for a straightforward approach to addressing its challenges. She believes that the funding gap, often portrayed as an insurmountable obstacle, can be viewed from different perspectives.

At first glance, the numbers can be alarming. The projected shortfall between costs and income over the next 75 years stands at a staggering $22.6 trillion. However, Munnell argues that this figure needs context.

When considered against the backdrop of the U.S. economy's size and growth trajectory, the picture changes dramatically. The funding gap shrinks to a mere 1.2% of the projected gross domestic product over the same 75-year period.

This analysis leads to Munnell's proposed solution: an increase in the payroll tax by 3.5 percentage points. Currently, employers and employees each contribute 6.2% (self-employed individuals cover the full 12.4%). Munnell suggests that this modest increase, without any other changes to the system, could largely resolve the funding issue.

By presenting the problem and its potential solution in these terms, Munnell offers a more digestible and less daunting perspective on Social Security's future. Her approach demonstrates that sometimes, complex issues can have surprisingly simple solutions when viewed through the right lens.

The Social Security Squeeze: A Demographic Dilemma

The current predicament facing Social Security isn't a sudden crisis, but rather the result of long-anticipated demographic shifts. As the baby boomer generation transitions into retirement  en masse, the system faces unprecedented pressure. This surge in retirees coincides with a decades-long decline in fertility rates, creating a perfect storm for Social Security's finances.

The crux of the issue lies in the imbalance between benefit recipients and contributing workers. While immigration has helped to some extent in bolstering the workforce, relying on increased immigration as a solution is politically contentious and thus, unrealistic as a primary strategy.

Interestingly, these demographic challenges were foreseen as far back as 1983, during the Reagan administration. At that time, a bipartisan commission led by Alan Greenspan, who would later become the Federal Reserve chair, crafted a legislative package to shore up the system's financial stability.

The resulting reforms were multifaceted. They included hiking payroll taxes to their current levels, implementing subtle benefit reductions, and building up a surplus in the trust funds. These trust funds, which have fluctuated since Social Security's inception in 1935, were designed to act as a buffer. The intention was for these funds to bridge the gap when the retiring baby boomers caused benefit payouts to exceed incoming revenue.

Stephen C. Goss, chief actuary for the Social Security Administration, shed light on the foresight of the 1983 reforms in his congressional testimony in 2023. He noted that at the time, projections indicated the trust funds would remain solvent until the mid-2050s. However, Goss emphasized that even then, policymakers were aware that further action would be necessary by that point.

Social Security's Looming Crisis: Earlier Than Expected

America's Social Security system faces a more urgent financial crisis than previously thought, with its projected insolvency now expected roughly two decades sooner than originally anticipated. Mr. Goss, cites two main causes:

1. Economic Downturn: The 2007-2009 recession was more severe and longer-lasting than most economists anticipated, significantly affecting long-term financial forecasts for the program.
2. Income Inequality: A sharp, unexpected rise in income inequality, particularly among the top 6% of earners, has strained Social Security’s funding. In 1983, the payroll tax covered 90% of total wages; today, with a taxable wage cap of $168,600, it covers only about 82.5%.

To return to the previous wage coverage level, Mr. Goss suggests raising the taxable wage cap to over $300,000. This adjustment could improve Social Security's long-term solvency. Without changes, the program needs a 3.5 percentage point tax increase to stay funded. However, by raising the cap, the necessary increase could drop to around 2.45 percentage points, targeting high earners while minimizing the impact on lower- and middle-income workers.

This solution could address both Social Security's funding gap and rising income inequality. Meanwhile, the program's financial stability remains at risk as policymakers debate potential fixes.

Securing America's Retirement: A Call for Proactive Social Security Reform

As concerns mount over the long-term viability of Social Security, experts are proposing various solutions to shore up this crucial safety net. Among them, Professor Munnell offers a straightforward approach: implementing an automatic "circuit breaker" mechanism. This safeguard could temporarily halt cost-of-living adjustments or fine-tune tax rates and benefits, preventing the system from veering too far off course financially.

While Munnell's proposal has merit, it may not fully address the growing income inequality that has exacerbated Social Security's funding challenges. A more comprehensive approach might involve raising the wage cap for Social Security taxes while simultaneously lowering the general payroll tax rate. This strategy isn't revolutionary; rather, it harkens back to the bipartisan reform efforts championed by Republican President Ronald Reagan and Democratic House Speaker Tip O'Neill in the 1980s.

The beauty of Social Security reform lies in its flexibility. Once serious discussions begin, a myriad of potential solutions will likely emerge. However, one option should be off the table: benefit cuts. With only about half of U.S. workers covered by retirement plans beyond Social Security, and even those with workplace plans facing uncertain financial futures, reducing benefits could have devastating consequences.

Policymakers face a choice: they can wait until the 2030s, when the threat of benefit cuts looms large and retirement anxiety reaches a fever pitch, or they can act now. The latter option offers clear advantages. By addressing Social Security's challenges proactively, millions of Americans could gain peace of mind about their retirement prospects.

The path forward isn't about reinventing the wheel but rather about fine-tuning a system that has served generations of Americans. By embracing reform now, we can ensure that Social Security continues to provide a stable foundation for retirement in the decades to come.

What can we learn from this story? What's the takeaway?

Good as we consider these options, it's critical to remember that Social Security isn't just a government program—it's a promise to American workers. Fulfilling that promise requires foresight, creativity, and a willingness to tackle tough challenges head-on. The time for action is now, before the looming crisis becomes an immediate reality.  

Well, there you go, my friends; that's life, I swear

For further information regarding the material covered in this episode, I invite you to visit my website, which you can find on Apple Podcasts/iTunes for show notes and the episode transcript.

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