The Social Security Trust Funds

Social Security provides cash benefits to seniors and non-seniors with a qualifying disability. These benefits are largely financed through payroll taxes on workers and their employers. Right now, you and your employer each pay 6.2 percent of your earnings for Social Security payroll taxes (up to a threshold called the taxable maximum). A small amount of revenue also comes from income taxes on Social Security benefits. The payroll and income tax revenue are then deposited into two trust funds: the Old-Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund.

The OASI Trust Fund goes to individuals who are at least 62 years old and worked in covered jobs for at least 10 years (40 quarters). It also funds benefits for workers’ spouses and dependent children as well surviving spouses and children of deceased workers. The DI Trust Fund pays for workers who haven’t reached age 62 if they suffer a qualifying disability.

Since the creation of Social Security, the amount of revenue it has collected has exceeded the amount spent on benefits. This difference has been credited to the trust funds. The reserves haven’t been sitting in a bank; instead, the money has been spent by the government on other programs. The government, however, hasn’t stolen from the trust funds; it has kept track of how much has been deposited and regularly credits the trust funds with interest payments. Charles Blahous, a former public trustee for the Social Security and Medicare Programs, explains how this accounting works:

In the past, whenever Social Security ran a surplus of taxes over expenditures, federal treasury bonds were issued in that surplus amount to its trust funds, which the program could later draw upon for future spending authority.  These bonds earn interest, which is paid from the federal government’s general fund. As long as there are assets in these trust funds, benefit checks can continue to be sent out—even after incoming payroll taxes become insufficient by themselves to finance the payments. 

The result of this accounting is that the OASI and DI Trust Funds had a combined $2.9 trillion in reserves at the end of the 2021.

While historically the total amount of revenue for Social Security has exceeded all benefits paid, since 2010 annual benefit payments have exceeded the payroll and income tax revenue dedicated to Social Security. The result is that trust fund balances are falling and are projected to hit zero in 2035. When this day comes it won’t be because the government used the money for other programs. To the contrary, when the trust funds run out of money, it will mean that every dollar of Social Security payroll tax revenue and all other dedicated Social Security revenue including interest will have been paid to Social Security’s recipients.

With no reserves remaining, the Social Security Administration will be legally prohibited from paying more in benefits than it collects in taxes. That means that if Congress does not act by 2035, Social Security benefits will need to be cut by about 20 percent for all recipients.

The complicated trust fund accounting obscures the simple challenge with Social Security: its costs are rising much faster than its income.

Some argue the answer is simply to raise payroll taxes. This can be done by an across-the-board rate increase, but that would mean tax hikes for all Americans. Policy makers could instead consider raising payroll taxes on high-income workers by making all earnings subject to Social Security payroll taxes. But, as the video below explains, high marginal tax rates discourage work, savings, and investment—the activities needed for economic growth.

Subjecting all earnings to the payroll tax would represent a dramatic increase in marginal tax rates for high-income earners. Right now, the top income tax rate is 37 percent plus an additional 3.8 percent for Medicare taxes. Adding the Social Security payroll tax would push the top rate to nearly 50 percent, or even higher if the employer share of the payroll tax is included.

Rather than raising taxes, there are proposals to change how benefits grow. Under current law, benefits are indexed to wage growth, which has historically grown faster than inflation. That means that each subsequent generation of retirees receives more in benefits after adjusting for inflation than the prior generation. Economist John Cogan offers an alternative to wage-indexed benefits in his chapter in Blueprint for America:

Benefit increases paid to future cohorts of retirees should be limited to the rate of inflation. Under a mistaken “wage-indexing” policy put in place four decades ago, the inflation-adjusted value of Social Security benefits rises from one cohort of retirees to the next. This means the average worker who is age fifty today can expect to receive a monthly Social Security benefit that is about 15 percent higher than today’s typical new retiree after adjusting for inflation. The average twenty-five-year-old worker today is promised an inflation-adjusted monthly benefit that is 36 percent higher. The United States can afford the current level of benefits, but not the promised increases.

Importantly, Cogan’s proposal to index initial benefits to prices rather than wages would not cut anyone’s Social Security check. And future retirees would receive the same benefit level that today’s retirees enjoy even after adjusting inflation. But slowing the growth in benefits would reduce Social Security’s projected expenditures, resulting in lower future federal deficits and an improved outlook for Social Security’s trust funds. Cogan also suggest slowly raising Social Security’s full retirement age to reflect the fact that people are living longer. Doing so would further reduce the growth in Social Security’s projected costs.