Social Security’s Finances
Social Security’s deficits are permanent and growing. In net-present-value terms, Social Security was estimated in 2013 to owe $12.3 trillion more in benefits over its 75-year projection horizon than it will receive in taxes over that period. This number includes $2.7 trillion to repay the special-issue bonds in the trust fund.
Net present value is the amount of money that would have to be invested today in order to have enough money to pay deficits in the future. In other words, Congress would have to invest $12.3 trillion today in order to have enough money to pay all of Social Security’s promised benefits through 2087. This money would be in addition to what Social Security receives during those years from its payroll taxes.
Social Security is the largest federal spending program, surpassing national defense since 1993. In 2012, the Old-Age and Survivors Insurance (OASI) Trust Fund, which pays for retirement and survivors benefits, took in $731.1 billion, which includes $102.8 billion that came from a paper transaction that credited interest to the trust fund. Excluding the interest, in 2012, the retirement and survivors program had an income of $628.3 billion but paid out $637.9 billion in benefits, leaving a deficit for 2012 of $9.6 billion. Additional deficits were suffered by Social Security’s disability program.
Counting both programs together, in 2012, Social Security spent $55 billion more in benefits than it took in from its payroll tax and income tax. This deficit is in addition to a $45 billion gap in 2011 and in addition to an expected average annual gap of about $100 billion over the next decade. These deficits will quickly balloon to alarming proportions.
The Trust Fund Does Not Make Social Security Healthy. The existence of a trust fund does not make Social Security healthy. Although those assets are guaranteed by the full faith and credit of the United States, the bonds it contains must be repaid using general revenue that would otherwise go to other programs. Similarly, the interest that Social Security receives on existing trust fund balances is not spendable income. It merely inflates the numbers in the trust fund and increases the amount that Social Security will eventually receive from general revenue. The only part that counts today is the cash that Social Security receives from the Treasury to cover its annual operating losses.
Many opponents of reform claim that raising payroll taxes by about 2.7 percent (the average percentage difference between revenues and outlays over the 75-year period) would permanently solve Social Security’s problems. The reality is that the program’s future deficits are projected to be both large andgrowing, so this tax increase would still leave a huge shortfall. Modest changes will not fix the current system.
The Taxes that Pay for Social Security. Unlike most other government programs, Social Security (like Medicare) is funded through explicit taxes that are not supposed to be used for any other purpose. These taxes are based on a worker’s earned income and deducted from his or her paychecks. For that reason, Social Security taxes are often referred to as “payroll taxes.” These payroll taxes are in addition to any income taxes that the worker must pay.
Separate payroll taxes finance Social Security’s retirement and survivors benefit program, Social Security’s disability benefit program, and Medicare; yet the three are often lumped together as one line item under “FICA” (see below) on a worker’s pay stub. The two Social Security taxes are paid only on income up to a certain annual amount. Medicare taxes are collected on all earned income.
In 2014, workers and employers will pay payroll taxes totaling 15.3 percent of the first $117,000 of income and 2.9 percent of income above that amount. The $117,000 dividing line is called the “earnings limit”—sometimes referred to as the “wage cap.” Of that 15.3 percent total, 10.6 percent of income pays for Social Security’s retirement and survivors program, and 1.8 percent pays for Social Security’s disability program. The remaining 2.9 percent is used to pay for Medicare programs, but the Medicare taxes are not subject to the earnings limit. In other words, Medicare taxes are collected on all of a worker’s earned income, not just the first $117,000.
The worker and the employer each pays half of the payroll taxes. The self-employed pay both portions.
FICA Defined. The paycheck stubs provided by most employers do not show the individual amounts that the worker pays for Social Security and Medicare. Instead, these taxes are lumped together and shown as a deduction for “FICA”—the Federal Insurance Contributions Act. FICA is the part of the Internal Revenue Code that gives the federal government the authority to collect the payroll taxes that pay for the Social Security programs and part of Medicare. The name implies that the taxes for these programs are actually contributions to a social insurance system. In reality, they are nothing more than taxes, and it would be more honest to refer to them as such.
Matching Deductions by the Employer. In most cases, only half of the Social Security taxes that a worker pays are shown on the paycheck stub. Employers pay an equal amount of payroll taxes on the worker’s behalf. As far as the employer is concerned, these additional taxes are part of the worker’s pay. Even though the worker never sees this income, the employer pays $10,765 for each $10,000 the worker earns ($10,000 in wages, $765 in payroll taxes).
Were this money not paid to the government as payroll taxes, it could go to the worker as wages. For this reason, both halves of the FICA tax should be counted as being paid by the worker. Thus, instead of paying taxes equal to 5.3 percent of income for retirement and survivors benefits, the worker is actually paying 10.6 percent of income. The combined total is the true cost to each worker.
Self-Employed Workers. This reality is clearly illustrated by self-employed workers, who must pay both the employer’s and the employee’s halves of the payroll taxes. Combining the payroll taxes for Social Security’s retirement and survivors program, Social Security’s disability program, and Medicare, the self-employed will pay a total of 15.3 percent of income below $117,000 in 2014. Moreover, they will pay an additional 2.9 percent of income between $117,000 and $200,000 ($250,000 for joint filers) and 3.8 percent of income above those income thresholds for Medicare. These payroll taxes are in addition to any income taxes.
Retirement and Survivors Tax. The largest portion of FICA payroll taxes is used to pay for a worker’s retirement and survivors benefits. The taxes pay for both the monthly benefits to workers who have retired and the monthly benefits (after the worker’s death) to the surviving spouse and children (under the age of 18). The worker and employer each pay 5.3 percent for a total of 10.6 percent of income up to the earnings limit for these programs. These taxes go into the OASI Trust Fund.
Disability Tax. Additional disability taxes equal to 1.8 percent of income (up to the earnings limit) go into the Disability Insurance (DI) Trust Fund, which pays monthly benefits to those who are unable to continue to work due to a long-term physical or mental disability. As with all payroll taxes, half of the amount (0.9 percent of income) is deducted from the worker’s pay, and the employer pays the other half on the worker’s behalf.
The Earnings Limit. In 2014, Social Security taxes will be collected on only the first $117,000 that a worker earns. This figure, the “earnings limit,” is adjusted each year. Social Security benefits are paid only on the amount of income that is subject to the Social Security payroll tax. Thus, in Social Security’s eyes, both Michael Jordan and Bill Gates earn $117,000 per year regardless of their actual incomes, and their Social Security retirement benefits will reflect this.
The earnings limit protects Social Security from having to pay benefits on Bill Gates’s entire income. It allows the program to cover all Americans without paying much higher benefits to the very rich than to average-income workers. Every October, the Social Security Administration calculates and announces the earnings limit for the following calendar year, based on the growth of wages in the economy. Wage growth is slightly higher than the rate of inflation (growth of prices).
Income Taxes on Some Social Security Benefits. Since 1983, retirees with annual income above a certain amount have been required to pay income taxes on a portion of their Social Security benefits. About one-third of Social Security beneficiaries are subject to tax. The money raised is returned to Social Security or Medicare.
Retirees with taxable income of $25,000 to $34,000 who file as individuals may have to pay income taxes on up to 50 percent of their benefits. If they have more than $34,000 in combined income, they may have to pay income taxes on up to 85 percent of their benefits. Married retirees whose combined income is between $32,000 and $44,000 may have to pay income taxes on up to 50 percent of their benefits, and if it is more than $44,000, up to 85 percent of their benefits may be taxable. These thresholds are not indexed for inflation. Income taxes on Social Security benefits are paid at the same rates as on other types of earned income.
Until 1983, all Social Security benefits were income-tax free. In that year, Congress decided to tax 50 percent of the Social Security benefits of workers with total retirement incomes over $25,000 (for single retirees) because the Social Security program needed additional revenue. Congress justified the move by pointing out that the half of payroll taxes paid by employers can also be deducted from the employers’ corporate income taxes, while workers must pay income taxes on the amount of their check that is deducted as payroll taxes. Congress decided that since companies received a tax deduction on the amount of payroll taxes paid on behalf of their workers, Congress could recapture that tax benefit by assessing income taxes on half of some retirees’ benefits. The money raised from this tax goes to the Social Security trust fund.
In 1993, problems with financing Medicare led Congress to raise the proportion of Social Security benefits that is subject to income taxes to 85 percent for workers with incomes over $34,000 (for single retirees). The money raised from this tax goes to the Hospital Insurance Trust Fund.