Would Taxing All Earned Income Resolve Social Security’s Growing Cash Shortfall? The Surprising Answer…

The most-popular solution to Social Security’s $22 trillion long-term funding shortfall would itself come up short.

For a majority of our nation’s retirees, Social Security income is a necessity to make ends meet. Estimates from the Center on Budget and Policy Priorities show that 22.7 million people are lifted above the federal poverty line annually via their Social Security payout, including 16.5 million adults aged 65 and over. Furthermore, 22 years of annual surveys from national pollster Gallup have found that between 80% and 90% of then-current retirees rely on their monthly benefit to cover at least some portion of their expenses. In other words, maintaining the stability of America’s top retirement program is vital to the financial well-being of our nation’s retired workforce. Unfortunately, the foundation for this nearly 89-year-old program is weakening with each passing year. Current retirees and future generations of beneficiaries are looking to their elected officials in Washington to shore up Social Security — and there appears to be a consensus on how best to “fix” this iconic program.

Demographic shifts have dug a $22 trillion (and growing) hole for Social Security

But before diving into the proposal that an overwhelming majority of working Americans favor, let’s dig into the details of how America’s leading retirement program found itself in a projected funding shortfall in the first place. For more than 80 years, the Social Security Board of Trustees has released an annual report that details the program’s financial health. On top of outlining how much revenue Social Security brought in during the previous year and where those dollars ended up, the Trustees Report takes into account various changes to fiscal and monetary policy, along with demographics shifts, to forecast how financially “healthy” Social Security will be in the 10 years and 75 years (the “long term”) following the release of a report. Since 1985, every Trustees Report has alluded to a long-term funding obligation shortfall. Mind you, this “funding obligation shortfall” doesn’t mean Social Security is in danger of becoming insolvent or going bankrupt. Instead, it means the existing payout schedule, including cost-of-living adjustments (COLAs), can’t be sustained over the next 75 years. As of 2023, the program’s long-term cash shortfall grew to $22.4 trillion. The more immediate concern is the projected depletion of the asset reserves for the Old-Age and Survivors Insurance Trust Fund (OASI), which doles out benefits to over 50 million retired workers each month, as well as 5.8 million survivors of deceased workers. The OASI’s asset reserves are on pace to be exhausted by 2033, which may necessitate sweeping benefit reductions of up to 23%. For the average retired-worker beneficiary, we could be talking about a loss of more than $6,600 per year by 2033. Despite social media message board pinning Social Security’s issues on myths like “congressional theft,” the program’s funding shortfall can be traced to a series of ongoing demographic changes. While not a comprehensive list, these shifts include:

• The steady retirement of baby boomers from the labor force.
• A marked increase in life expectancy since retired-worker payouts began in January 1940.
• A 25-year decline in net-legal migration into the U.S.
• A historic drop-off in U.S. birth rates.
• Rising income inequality that’s allowed more earnings to escape payroll taxation.

THE OASI’S ASSET RESERVES MAY BE EXHAUSTED BY 2033. US OLD-AGE AND SURVIVORS INSURANCE TRUST FUND ASSETS AT END OF YEAR DATA BY YCHARTS.

Would taxing all earned income resolve Social Security’s problems?

“Fixing” Social Security isn’t a matter of coming up with ideas — lawmakers on Capitol Hill have introduced no shortage of bills to address Social Security’s funding shortfall. Rather, it’s deciding which idea(s) works best. Among the numerous proposals that have been put forth in Washington and on social media message boards, none is more popular than the idea of taxing all earned income (wages and salary, but not investment income) for high-earning Americans. Two-thirds of respondents polled in 2005 and 2010 by Gallup favored requiring high earners to pay taxes on all their wages. In 2024, all earned income between $0.01 and $168,600 is subject to Social Security’s 12.4% payroll tax. Approximately 94% of workers will generate less than $168,600 in earned income this year, which means they’ll be paying into the program with every dollar they earn. As for the remaining 6% of workers, any wages and salary above $168,600 is exempt from the payroll tax. While on the campaign trail in 2020, then-candidate Joe Biden proposed increasing payroll taxation on the rich to strengthen America’s top retirement program. Biden’s plan called for reinstating the payroll tax on earnings above $400,000, while creating a doughnut hole between the maximum taxable earnings cap (the $168,600 figure) and $400,000 that would slowly close over multiple decades. However, some voters would like to see this plan taken one step further by exposing all earned income to taxation right now. The million-dollar question is: Would taxing all earned income resolve Social Security’s cash shortfall? The answer, according to one close-to-the-source analysis, is no. It’s easy to understand why taxing high earners is such a popular solution. Since 94% of workers are already paying into the program on every dollar they earn, increasing payroll taxation on high earners would only affect about 6% of the labor force. But according to a study from the Social Security Administration’s Office of the Chief Actuary in 2021,

[I]f all earnings were subject to the payroll tax, but the current-law base were retained for benefit calculations, the Social Security trust funds [OASI and Disability Insurance Trust Fund, combined] would remain solvent for about 35 years.

To be clear, taxing all wages and salary does strengthen Social Security and would kick the can on potential asset reserves depletion dates more than three decades into the future. However, taxing the rich, by itself, doesn’t come close to resolving Social Security’s long-term funding obligation shortfall. It would certainly buy lawmakers additional time to find solutions to shore up America’s leading retirement program, but it’s absolutely not the cure-all proponents believe it is.