For a majority of future retirees, Social Security will play a key role in their financial well-being. We know this because more than two decades of annual surveys from national pollster Gallup have shown that between 76% and 88% of non-retirees expect to rely on their Social Security benefit, in some capacity, to make ends meet during their golden years.

Although Social Security has been a guaranteed source of payouts for eligible retired workers since the first payouts began in January 1940, this all-important program is on ever-shakier financial footing.

Americans are looking to their elected officials in Washington, D.C. to shore up America’s top retirement program — and that begins at the top with President Joe Biden.

Joe Biden speaking with reporters in the East Room of the White House.

President Biden delivering remarks. Image source: Official White House Photo by Adam Schultz.

Social Security’s long-term funding shortfall has surpassed $22 trillion

For more than eight decades, the Social Security Board of Trustees has released an annual report that details the program’s current financial health, as well as makes assumptions about its financial outlook over the 10 years and 75 years (the long term) following the release of a report. These assumptions can be altered based on changes in fiscal and monetary policy, as well as demographic shifts.

Every year since 1985, the Social Security Board of Trustees Report has cautioned that Social Security is facing a long-term funding shortfall. As of the 2023 report, the program’s estimated funding-obligation shortfall had ballooned to $22.4 trillion (through 2097).

To be clear, a funding shortfall doesn’t mean bankruptcy or insolvency. Rather, it means the existing payout schedule, including cost-of-living adjustments (COLA), isn’t sustainable.

The 2023 Trustees Report projects that the Old-Age and Survivors Insurance Trust Fund (OASI), which is responsible for doling out monthly benefits to more than 50 million retired workers and approximately 5.8 million survivors of deceased workers, could exhaust its asset reserves by 2033. Should the OASI’s asset reserves be depleted, sweeping benefit cuts of up to 23% may be needed to avoid any further reductions through 2097. By 2033, this would reduce the average annual take-home benefit for retired-worker beneficiaries by more than $6,600!

While social media message boards are littered with false claims that Congress has stolen from Social Security or that undocumented workers are receiving benefits, the reality is that Social Security’s cash shortfall boils down to ongoing demographic changes. Some of the more important shifts that are adversely impacting Social Security include:

  • A historically low U.S. birth rate, which threatens to further reduce the worker-to-beneficiary ratio for future generations.

  • Rising income inequality, with a greater percentage of earned income escaping the payroll tax.

  • A more-than-halving in net legal migration into the United States. Migrants entering the U.S. are usually younger and will spend decades in the workforce contributing to Social Security via the payroll tax.

US Old-Age and Survivors Insurance Trust Fund Assets at End of Year Chart

US Old-Age and Survivors Insurance Trust Fund Assets at End of Year Chart

Joe Biden’s four-point plan to “fix” Social Security relies on the wealthy “paying their fair share”

Now that you have a better understanding of why Social Security is in trouble, let’s take a closer look at the plan Joe Biden presented prior to being elected president in November 2020.

While on the campaign trail, Biden and his team unveiled a four-point proposal designed to strengthen Social Security. One of these points is critical to the plan’s success — and it’s something Biden emphasized during his recent State of the Union address.

1. Increase payroll taxation on the wealthy

The essential aspect to Joe Biden’s Social Security proposal is that the rich “pay their fair share.” This would be accomplished by increasing payroll taxation on the wealthy.

In 2024, all earned income — i.e., wages and salary but not investment 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. Meanwhile, the other 6% of workers will have their earned income above $168,600 exempted from Social Security’s payroll tax.

Biden’s approach would see the payroll tax reinstated on earned income above $400,000, with a doughnut hole created between the maximum taxable-earnings cap (the $168,600 figure) and $400,000 where earnings would remain exempt from the payroll tax. The key is that the maximum taxable-earnings cap rises on par with the National Average Wage Index over time. Thus, over a couple of decades, this doughnut hole would close and expose all earned income to the payroll tax.

2. Shift Social Security’s inflationary tether from the CPI-W to the CPI-E

In addition to raising revenue by reinstating the payroll tax on well-to-do workers, Biden’s plan involves lifting benefits for those who need it most. This would begin by shifting Social Security’s inflationary tether from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to the Consumer Price Index for the Elderly (CPI-E).

Although the CPI-W has been Social Security’s COLA-determining tool since 1975, it hasn’t done a particularly good job. That’s because it’s tracking the spending habits of “urban wage earners and clerical workers,” many of whom are younger and not receiving a Social Security benefit at the moment.

The CPI-E would strictly focus on the spending habits of households with persons aged 62 and above, which would be expected to result in more accurate (and higher) annual COLAs.

3. Boost the special minimum benefit above the federal poverty level

The third piece of the puzzle is lifting the special minimum benefit. In 2024, a lifetime low-earning worker with 30 years of coverage can expect to receive no more than $1,066.50 per month. That’s notably below the federal poverty level for a single filer of $1,255 per month this year.

Biden’s plan calls for an increase to the special minimum benefit to 125% of the federal poverty level, with inflationary adjustments made in subsequent years.

4. Gradually lift the primary insurance amount for aged beneficiaries

Last but not least, then-candidate Joe Biden called for a gradual increase to the primary insurance amount (PIA) for older beneficiaries. The PIA would be stepped up by 1% annually, beginning at age 78 and continuing through age 82, until a 5% aggregate increase is realized.

The purpose for this increase is to help offset higher expenses as we age. For instance, prescription medicine costs and medical transportation expenses can rise as we get older.

A couple reading material on a shared laptop while seated at a table in their home.

Image source: Getty Images.

Joe Biden’s Social Security solution would come up short in more ways than one

On paper, the president’s proposal appears to make sense. Raising revenue from taxing the wealthy would help offset the immediate cash crunch the OASI is facing. At the same time, some of the revenue raised from taxing the rich can be repurposed to helping the beneficiaries who need it most.

However, a deeper dive into Biden’s Social Security proposal by researchers and economists reveals that it isn’t as cut-and-dried as you might think.

In October 2020, three researchers at Washington, D.C.- based think tank Urban Institute analyzed Biden’s proposal and came to a clear conclusion. While it does extend the solvency of the OASI’s asset reserves, it doesn’t come anywhere close to resolving Social Security’s long-term funding-obligation shortfall. As the publication notes:

We project that by extending the Social Security payroll tax to earnings above $400,000, his plan would close about a quarter of the program’s long-term funding deficit and extend the life of the trust funds [the OASI and Disability Insurance Trust Fund on a combined basis] by about five years.

Though taxing the wealthy has the potential to push the OASI’s asset-reserve exhaustion date decades into the future, Biden’s plan to repurpose most of this raised capital to increase the special-minimum benefit, lift the PIA for aged beneficiaries, and increase COLAs for all beneficiaries by switching to the CPI-E offsets much of what would be gained.

In a separate study conducted in March 2020, economists at the Penn Wharton Budget Model (PWBM) found additional concerns with Joe Biden’s Social Security proposal. While it would help “reduce the conventionally measured long-range imbalance by 1.5 percent of taxable payroll,” PWBM’s economists note that Biden’s plan leads to adverse consequences for the U.S. economy. Specifically, it would lower estimated U.S. gross domestic product (GDP) by 0.6% in 2030 and 0.8% by 2050.

The first issue raised by PWBM is that the broad-based increase in COLAs caused by the shift to the CPI-E would coerce workers with adequate retirement savings to work less and/or retire earlier. This means less productivity for the U.S. economy and therefore reduced GDP.

The second issue raised by PWBM’s economists is that raising the payroll tax on the wealthy would “distort labor supply decisions by more than the current payroll tax.”

While workers don’t get back the same dollar they put into Social Security, there exists the perception of a “contribution-benefit” link. In other words, if a worker has to pay more into the system, there’s the expectation that their payout will be greater during retirement. Biden’s plan disrupts this perception and would coerce the wealthy to work less, defer their income, or seek out ways to generate income that wouldn’t be subject to the payroll tax.

Although Biden’s Social Security proposal would, indeed, strengthen Social Security by extending the solvency period of the OASI’s asset reserves, it comes up short in a variety of other aspects.

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Joe Biden Wants to Tax the Rich to Save Social Security, but This Isn’t as Cut-and-Dried a Solution as You Might Think was originally published by The Motley Fool

Source: finance.yahoo.com