For many Americans, Social Security is already, or will become, an important part of their monthly retirement income. According to annual surveys conducted by Gallup over the past two decades, social security payments represented a “main” source of income for at least 54% of respondents in all but one year.
For decades, this top-tier retirement program has done a fantastic job in pulling older Americans out of poverty and in providing some form of financial plan for retirees. Unfortunately, it is also a program that keeps getting closer and closer to disaster.
Social Security is setting a $ 20 trillion abyss
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Every year since payments to retired workers began in 1940, the Social Security Board of Trustees has published a report outlining the short-term (10-year) and long-term (75-year) outlook for the program. This report typically over 200 pages takes into account a myriad of economic and demographic changes to determine how “healthy” social security is financially.
Since 1985, this annual report has served as a warning that Social Security is estimated to have insufficient income to cover its expenses (ie, benefit payments) in the long run. The 2022 report estimates a liquidity shortage of $ 20.4 trillion through 2096, with over half a dozen factors contributing to this shortage.
More importantly, the latest report from the Trustees illustrates the reasons why the Old-Age and Survivors Trust Fund (OASI) will deplete its reserves of assets – its excess liquidity accumulated since the beginning – by 2034. L ‘OASI is what analyzes the payments to over 48 million retirees every month. If these reserves of assets run out, a general 23% cut in benefits may be needed to support ongoing payments through 2096.
There are practically only two levers to pull when it comes to “fixing” the impending shortage of Social Security money: increase additional income or reduce costs. Since most people aren’t thrilled with the prospect of reducing monthly payments or lifetime benefits, rising revenue is where the pendulum often swings.
This hated source of income will become more important over the next decade
Last year, Social Security generated just over $ 1.08 trillion in revenue from three sources. The 12.4% payroll tax on earned income accounts for the lion’s share of income. Last year it generated 90.1% of the $ 1.08 trillion raised.
The second source of revenue is net interest income, which represented $ 70.1 billion in revenue. The capital reserves of the program must be invested by law in special-issue government bonds and debt certificates. The interest earned on these bonds and debt certificates help fund Social Security benefits.
Finally, there is the most controversial source of revenue: the taxation of benefits.
In 1983, with the program’s capital reserves nearly exhausted, then President Ronald Reagan signed the latest bipartisan social security review. In addition to gradually increasing the payroll tax and full retirement age, he introduced the taxation of social security benefits, which came into effect in 1984.
When first introduced, up to 50% of the benefits could be exposed to federal taxation if a person’s modified adjusted gross income (MAGI) plus half of the benefits exceeded $ 25,000 (or $ 32,000 for a couple presenting jointly). In 1993, the Clinton administration added a second tier that allowed federal taxation of up to 85% of benefits if the MAGI formula plus half of the benefits exceeded $ 34,000 for a single file or $ 44,000 for a couple who jointly presents.
Last year, taxation of benefits brought in $ 37.6 billion, or 3.5% of total revenue. By 2031, the intermediate cost model (that is, the cost model that Trustees believe is most likely to occur) predicts that taxation of benefits will represent revenue of $ 112.7 billion, or 6.3% of the expected income for the entire year for social security.
Taxation of benefits is expected to generate $ 775 billion in revenue over the next decade.
Taxation of benefits is the necessary evil of social security
To say that the taxation of benefits is despised by the elderly might be an understatement. Five years ago, The Seniors Center interviewed retirees about ways to “ease the burden of rising cost of living for the elderly.” A whopping 91% of respondents suggested that no longer taxing Social Security benefits would be a smart move.
The single biggest problem with the taxation of social security payments is that the aforementioned income thresholds that subject beneficiaries to tax have never been adjusted for inflation. Each cost of living adjustment passed on to program beneficiaries leads to more and more recipients being hit by federal taxation on what they receive. According to The Senior Citizens League, in the neighborhood half of all households who receive a Social Security payment can pay a certain amount of tax on their benefits this year.
However, this unwelcome source of revenue is unlikely to disappear anytime soon, if at all, for two key reasons.
First of all, Social Security needs as much revenue as it can get to prevent its already massive $ 20.4 trillion long-term cash shortage from spreading further. This means not only continuing to collect tax on benefits paid beyond certain income thresholds, but ignoring the lack of inflationary adjustments to income thresholds after several decades.
The second issue is that removing the taxation of benefits would require bipartisan support in the Senate, which has been virtually impossible to obtain for social security in recent decades. Although there are a couple of shortcomings in the program that Democrats and Republicans agree on exist, the two parties have approached solutions from opposite ends of the spectrum and have been unwilling to meet their opposition in between.
Given the financial situation of social security, taxation of benefits is a necessary evil that will only increase in importance in the next 10 years.
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