Social Security: A quick background, why the pot is draining, and ways to solve it

The Social Security Act came into effect in 1935.  It was designed to pay retired workers over 65 a continuing income stream.  In 1939 benefits were added for survivors, the retiree’s spouse, and children.  In 1965, disability benefits were added.  It was never intended to be the full income of a retiree, but according to the Social Security Administration (SSA), almost 25% of all retirees rely on social security for over 90% of their income.  In addition, over 50% rely on it for over half of their retirement income[1].  The question of why the Social Security program is not solvent long-term and how to solve it requires a much deeper dive.

Social Security is paid for by a payroll tax.  This tax is 12.4% in total, paid for in half by the employee and half by the employer. When it began, it was taxed 1% on the first $3k of income.  Today it continues to be paid on the first $160,200 of earnings.  It should be noted that for twenty-three million sole proprietorships in the US, the most popular form of business entity in the US, the business owner pays the full 12.4%.  In other words, the 73% of business owners choosing to live their American dream of being self-employed currently pay twice the percent amount of payroll tax as an employee.

Social Security uses a Primary Insurance Amount (PIA) to calculate benefits. This is based on past average indexed monthly earnings (AIME) during a worker’s highest 35 years of employment history.   What is important to understand is how the formula for these benefits are calculated.

90% of the first $1,115 of AIME, plus

32% of the next $5,606 of AIME, plus

15% of AIME more than $6,721.[2]


It should be noted that the more money one earns, the less they get back from social security in the form of the return of those payments.  That is a fact based on how Social Security is calculated.

Social Security was initially not taxed, but now retired married couples earning over $44k per year (or singles earning over $34k per year) are taxed on 85% of their payments at their ordinary marginal tax rate.

In other words, those that earn more prior to and during retirement tend to get much less back as a percentage of what they funded into the system due to how their benefit is calculated and how they are taxed on it upon receipt.

According to the SSA, retirees relying on this income to a greater extent tend to be unmarried, over 75, and have less than a high school diploma.  Those that rely to a lesser extent are married, have college degrees, and are early in their retirement.  Women rely on it more than men.[3]  Not everyone should go to college, and women tend to live longer than men.  While helpful to understand, these are irrelevant to the actual issue of social security’s solvency in the same way that a wage earner making $175k per year in his or her prime earning years is not paying his or her ‘fair share’.

In 1942, there were 42 workers per retiree.  Today the ratio is 3:1. In 2050, it will be 2:1 as fertility rates decline in the US.  Since 1940, life expectancy among men and women has increased around 12 years and it continuing to increase.  The baby boomer generation is huge and retiring, while the next generation that I fall into is not as large.  Labor participation rates have dropped significantly over the past 30 years.  While it is evident that people across the globe desire to become U.S. citizens as supported by the mass increase of immigrants[4], if they are undocumented immigrants, they are not contributing to the payroll taxes because they are being paid in cash (also called ‘under the table’).

According to the Congressional Budget Office, Social Security revenues in 2034 will need to be reduced by 23% assuming no changes.  This is when the trust fund runs dry.  It does not mean that the system is bankrupt, but rather that the payroll taxes to cover the payments are not enough. This is an important distinction. Since it is a pay-as-you-go program, if there is not enough revenue coming in to cover the costs then the benefits must shrink if no changes are made.

The reality of social security is that those that put more into the system get far less back as a percent contributed.  However, this security blanket is vital to lower income earners and why they should receive more as a percentage back in retirement.  It was intentionally designed in a way to help lower income earners to a greater extent, and continuing this benefit is a high priority item.

So how do we solve it?  Most in the financial industry know that it could be solved on a napkin with a variety of strategies. The issue has become political with misinformation about how it works and the ways to solve it.

Most political solutions to date take a one-sided approach.  This will not work to solve the problem when according to Pew Research just 6% of Americans agree with the phrase that the government is ‘careful with taxpayer money’[5].

To compromise on this issue, here are a few ideas that when taken together can help:

First, take off the table any reduction in benefits to current retirees or those over 50. This relieves the misguided notion that any party wants to reduce benefits to those receiving it now or reasonably expecting to in the next 15 years.

Second, look at delaying social security in phases for those prior to age 50.  As suggested earlier, ‘fair share’ is subjective and determined by the eyes of the beholder. People are living longer.  The younger generation is buying homes, getting married, and having children later in life, so it does not appear unreasonable to delay time until receipt of Social Security.

Third, increasing the payroll tax becomes a heavy burden on the small business owners in our country. Considering the average net income of a sole proprietor is around $75k per year and half do not survive past five years, increasing the payroll tax has a direct effect on this middle-class segment and an indirect effect on incentivizing the creation of new businesses to support the growth of our country that was founded on free enterprise.  For these reasons, leaving out an increase on the payroll tax would be wise to gain momentum for a compromise.  If it must be changed to politically pass, then the smallest increase possible is recommended, but the preference is to widen the labor participation rate instead of increasing the tax on those currently participating.

Fourth, increasing the wage ceiling on the payroll tax is a different option and one that should be considered, but a plan to have no ceiling would result in new compensation strategies by executives to avoid this altogether and completely miss on the intended purpose.  The economics of this are interesting.  Let’s say the ceiling is bumped up to $250k.  A recent Bloomberg study noted one-third of Americans making over $250k live paycheck to paycheck due to rising inflation and household expenses[6] (they should hire a financial planner but that is for another article). The point here is that definitions of rich or very wealthy vary based on perspective and that increasing the wage ceiling is a fine idea but will eventually have diminishing results.

Fifth, since our economy is driven on consumption, and tax increases lead to a drop in consumption, why not focus on how to increase the labor force in our country to increase the overall payroll tax.  This is clearly a larger discussion because it includes immigration policy to attract workers.   According to NBC, the number of illegal border crossing in 2022 was over 2.7 million.[7]  This is greater than the population of Philadelphia, Baltimore, and Pittsburgh combined.  Imagine a comprehensive plan to get these workers legally paying into the system.

All parties giving a little will go a long way.  Of course, this means that nobody is completely satisfied, but from my experience this is what compromise looks like and tends to result in a long-term solution with a higher probability of achieving its purpose.

Finally, for all of this to work, the tone at the top and at the bottom from both parties would benefit from an avoidance of targeted, campaign-style rhetoric meant to produce votes from fear rather than produce outcomes from a mutually beneficial resolution to continue Social Security for all Americans.

Life is not fair, so coming to an agreement among all of us on how to define what someone’s ‘fair share’ is only divides us based on one’s perspective.  We all work hard and have a mutual incentive to ensure this pay-as-you-go program is sustainable.  Just maybe, the idea that ‘fairness does not mean everyone gets the same but rather everyone gets what they need’ could be adopted by all parties involved in reaching consensus for settlement of the above ideas.



[2] 2023 Guide to Social Security, 51st Edition






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