When Darlene Friel was 14, her father died. Soon, her grandparents received monthly checks for Darlene as part of the Old-Age, Survivors and Disability Insurance program, the formal name of Social Security.
Friel collected about $500 a month until she graduated from high school at 18. Today, at 53, the Absecon, N.J., office manager worries about getting by when she is too old to work. "I fear the only Social Security money I will ever collect was after dad died," she says.
Like millions of other Americans, Friel worries that there will be a day when Social Security isn’t there anymore.
Today, we’re just 10 years from a full-blown Social Security crisis. The system now pays out more in benefits than it collects in payroll taxes. The 12.4% tax — half of the tax is paid by workers through payroll deductions, the other half by employers — doesn't quite equal benefits.
If Congress does nothing to fix the system, as Friel fears, benefit checks to retirees, surviving spouses, orphaned children and disabled people will have to be cut 27% beginning in 2034, the program’s trustees estimate.
But like many Americans, Friel doesn't trust Congress will meet the crisis. "I just don't believe Congress will do anything," she says.
I’m also concerned, having reported on Social Security, public finance and taxes since the 1960s and always doing my own economic analysis in articles, columns and books. I know we can get real reforms, but we have to demand them from Congress.
Benefit payments last year totaled almost $1.1 trillion — a fifth of federal spending — paid to 67 million people. Revenue ran short by 3.7%, forcing the Social Security Administration to tap $41 billion from its $2.7 trillion trust fund, built up since the 1980s.
Twenty years ago, the Social Security trustees estimated the trust fund would last until 2042, when the youngest Boomers would turn 78. The trustees now say it will run dry at the end of 2033 — unless voters persuade Congress to step up and enact reforms.
Miriam Alexander, who runs a small qualitative data analytics firm in Los Angeles, worries that even if Congress does act, it may choose to cut benefits. She worries less about herself than about low-paid workers. She worries lawmakers may loot Social Security under the guise of reform.
"There's a bunch of money-grubbing, selfish people who don't see the value of living in a society where we care for each other," the businesswoman says.
Reason Magazine writer Eric Boehm has a very different idea. “The ultimate libertarian approach would be to do away with Social Security entirely,” he said last year, adding that “if Congress wanted to propose that, I would probably support it — depending on the specifics.”
How ’80s Social Security reforms worked
The last time Congress undertook a significant overhaul of Social Security, during the Ronald Regan administration, it changed the program's finances from a pay-as-you-go system to a pay-in-advance program.
Instead of collecting just enough in taxes to pay benefits, as it had since 1935, Congress adopted a proposal by a special commission requiring workers to pay more than needed to build up the trust fund. The commission — headed by Alan Greenspan, who would later chair the Federal Reserve through four administrations — said the fund would assure adequately funded retirements for the Baby Boomers, who would be paying the increased taxes as they moved through the workforce.
Congress then used those excess payroll taxes to compensate for the much lower income tax rates that have prevailed since the 1980s and gave the Social Security Administration non-tradeable Treasury bonds earning an average of about 2.4%.
The trust fund has assured benefits for the Boomers as the huge demographic bulge passed through time. But — along with some bad timing — it has also helped to weaken the overall retirement system.
Prior to the 1980s, comfortable retirements were built like a three-legged stool held up by company or union pensions, Social Security and individual savings. But the pay-in-advance plan severely curtailed Boomers' capacity to save. The nation’s personal savings rate declined, roughly matching the extra Social Security taxes paid. This led to less individual savings while, at the same time, unions were declining and corporations were replacing pension plans with less generous 401(k) retirement plans.
What happened to Social Security? And why?
The Social Security crisis is not just a case of too few workers supporting too many retirees. To understand why Social Security is teetering, you have to understand some of the ways the U.S. economy has changed since the 1980s — especially incomes, which are the source of Social Security revenues.
The Greenspan Commission concurred with a Congressional recommendation that 90% of all salaries and wages be subject to the Social Security tax. That was the case in the early 1980s, but over time the rate slowed down. Only about 82% are taxed today.
That created the $41 billion shortfall in 2022. Had 90% of wages been taxed, my calculations show, instead of a shortfall, the system would have had a $64 billion surplus.
But over the long haul, restoring the 90% rule may not bring in enough money and won't allow increased benefits to the poorest workers. That’s because something else has happened to incomes.
Since the early 1990s, workers far up the pay ladder have received the lion’s share of pay raises. The formula the Social Security Administration uses to calculate the maximum pay subject to the payroll tax didn't anticipate an economy in which executives and professionals with salaries already well above the taxable income cap — currently $168,600 — would take bigger slices of the national wage pie.
In 2020, for instance, 63% of the money paid out in raises went to just 184,000 people making $1 million or more, my annual analysis of W-2 wage report data found. Their average raise was $84,000, none of which was subject to the Social Security tax. The average pay raise for the other 167 million workers was just $570. As a result, most of the increase in overall wages has not been subject to Social Security taxes, placing a further drain on the money available to pay benefits.
Finally, another unanticipated change in the economy since the reforms was a shift of income sources away from work and toward investment gains. IRS data show that wages and salaries accounted for 78% of national income in 1993 but only 61% in 2021. The rest came from increased business profits, capital gains, dividends and some royalties — none of which is subject to the Social Security tax.
So, what to do?
Here are some of the proposals on the table in Washington:
End Social Security: When Mike Lee of Utah ran for the U.S. Senate in 2010, he declared, "It'll be my objective to phase out Social Security, to pull it up by the roots and get rid of it." Lee said that retirees and those nearing retirement should collect, but the program should be closed to young people. Senator Lee (R-Utah) has never again called for abolishing Social Security.
Senators Rand Paul (R-Ky.) and Ted Cruz (R-Texas) haven’t called for shutting down Social Security, but they have been among those who want to end the payroll tax that funds it. Neither has suggested how to finance Social Security without its dedicated payroll tax.
Ending Social Security or cutting benefits would affect more than 58.6 million retirees and their dependents and 8.5 million disabled people. Those with families could call on them to help make up for the lost Social Security retirement and disability benefits.
But Social Security is the sole source of income for about 40% of retirees, estimates the National Institute on Retirement Security. If Congress ended Social Security this year, it would plunge almost 23 million beneficiaries into poverty, census data show, and shift costs and taxes from the federal level to local governments.
Many beneficiaries would end up on welfare rolls, which state and county governments administer. For each dollar paid in benefits, the Social Security Administration spends less than a penny running the system. It’s unlikely that 3,000 expanded county welfare programs could operate more cheaply.
Privatize Social Security: President George W. Bush proposed partially privatizing Social Security on the theory that younger workers would do better investing some of their tax dollars. Opposition, mainly from retirees citing the inherent risks in investing, prompted Bush to drop the proposal.
There are other problems with privatizing even a portion of the funds flowing through the Social Security system. Social Security already pays out more than it takes in, so in order to maintain current benefits any diversion of taxes to private accounts would have to be made up some other way — presumably with new taxes.
Any Social Security tax money flowing into investment accounts would have an enormous impact on the stock market. Consider the effect of pouring an additional $200 billion or more into the market each year. Share prices would likely inflate, creating a market bubble that might then eventually collapse and take retirement funds down with it.
And, of course, Wall Street brokers and banks would charge fees to manage accounts, a significant drag on low-wage workers with small balances.
Raise the retirement age: When Social Security began, the retirement age for full benefits was 65. It’s now 67 for anyone born since 1960. That's a two-year, $42,000 benefits cut to someone receiving the average monthly payout.
Now Washington is alive with talk about raising the full retirement age to 69 or 70 years. The problem is that raising the retirement age favors well-paid, white-collar office workers over people who do physical labor and may be unable to work late into their sixties.
One solution to this disparity would be to create a two-tier retirement system that gives workers in certain occupations or whose earnings are below a set level the ability to retire sooner with full or even increased benefits. But such a reform would be complicated and subject to legal challenges as Congress, in effect, would be creating separate and unequal Social Security benefits systems.
Raise the tax rate: Raising the 12.4% tax rate to about 15% should generate enough money to pay full benefits for decades.
By the end of this century, the last of the Boomers will be long gone, easing financial pressures. But rapid changes in technology could upend any workplace projections. The effects of artificial intelligence and other technological innovations are far from clear. Software may replace vast swaths of jobs.
Raising the tax rate would encounter political opposition across the political spectrum. President Joe Biden vowed to reject any tax increase for people making less than $400,000 yearly, roughly the threshold for the top 2%. Donald Trump says he supports Social Security but has been vague about what policies he would pursue to stabilize the program.
Raise the tax cap: Congress could lift or eliminate the $168,600 ceiling on wages subject to the Social Security tax.
Nancy Altman, who worked on the 1983 commission staff, favors a version of this option. She is now president of Social Security Works, a nonprofit that favors increasing benefits.
"Raising the cap on taxed wages to $250,000 would be a substantial step in securing Social Security's long-term future," Altman says. But, she adds, why not apply the tax to all wages, including the 504 highest-paid employees, whose average pay in 2021 was $151 million each?
Applying the tax to all pay in 2022 would have raised an additional $235 billion, my calculations show. That's enough to significantly increase benefits for all retirees and people on disability.
A short-term problem with this idea is President Biden's line-in-the-sand stance that no one making under $400,000 will pay higher taxes. Any reform, then, would no doubt require a Medicare Part D-type doughnut hole. The tax would apply to wages up to $168,600, then untaxed until wages reach $400,000, and then taxed above that level. That approach could be popular with the nine million or so workers whose pay would be partly in the tax-free donut hole.
The strongest argument against Altman's idea is the prospect that, under the standard benefits formula, some retirees could collect more than $1 million annually, which would likely prompt taxpayer outrage. A cap on benefits of two or three times the current maximum benefit of almost $60,000 a year, could address that concern.
Tax all pay: The best solution, I think, is applying the Medicare policy of taxing 100% of compensation to Social Security. If designed like the Medicare tax with a higher rate on incomes above $200,000, or even $1 million, it would allow lower tax rates for most workers and enable retirees who earned low wages to collect increased benefits.
Asked to choose between cutting benefits or raising taxes to maintain benefits, twice as many people, 61%, favored higher Social Security taxes, a December Gallup poll found. Support for maintaining the system crosses party lines, Gallup noted.
There's also an easy way to make such a change broadly popular. Congress could end the practice, begun in 1984, of taxing Social Security benefits. Seventy-five percent of retirees pay income taxes on their Social Security benefits.
Making those benefits tax-free would reduce income tax revenues by about $47 billion, a sum that would be more than offset by imposing the Social Security tax on all pay. And cutting the income tax, most of it paid by people with middle-class incomes, would be the equivalent of a benefits increase among a politically influential group of Americans.
Bonus section: Built-in benefit cuts for richer retirees
Social Security applies some complicated arithmetic to determine benefits under rules set by Congress. Basically, low-wage earners receive more money over their retired lives than they paid in during their working lives while high-wage earners receive less.
High earners, who presumably saved more over their careers, are then hit with income taxes that further reduce their benefits.
Based on her life expectancy at retirement, a waitress who never earned more than $30,000 a year can expect to receive about $1.51 for every dollar she paid in Social Security tax over her highest-earning 35 years at work, according to a study last year by the nonprofit Tax Policy Center.
Low-earning men can expect to receive $1.35 for every dollar paid in. Men collect less because they typically live fewer years than women.
In contrast, a corporate vice president who paid the maximum Social Security tax for her entire career can expect to receive just 74 cents for every dollar paid in. A high-earning man would collect 69 cents.
A low-income married couple who together never made more than $66,000 a year would collect $1.43 on each dollar of tax paid. A couple whose combined pre-retirement pay was $172,000 a year would get back 98 cents.
Today, three-quarters of Social Security retirees pay income tax on their benefits under a 1983 law signed by President Ronald Reagan. Taxes were raised again during the Bill Clinton administration.
Currently, a married couple earning $32,000 a year — including half of their Social Security benefits as well as pensions, retirement account distributions, salaries and other sources — pays income taxes on half of their Social Security benefits. If the couple makes more than $44,000, Congress taxes 85% of their benefits — equivalent to a cut of over 20%. (And very high-earners’ benefits are further cut by increased Medicare premiums.)
Fortunately, most states don’t tax Social Security benefits. Only nine do: Colorado, Connecticut, Kansas, Minnesota, Montana, New Mexico, Rhode Island, Utah and Vermont.
Note: This item first appeared in Kiplinger’s Retirement Report, our popular monthly periodical that covers key concerns of affluent older Americans who are retired or preparing for retirement. Subscribe for retirement advice that’s right on the money.
