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Social Security

Medicare and Social Security Deficits

Earlier this week, I presented a program on economics, regulation, and taxes for the Active Senior Republican group. After the presentation, I was talking to one of the attendees about Social Security, and it got me thinking that there is a lot of misunderstanding about how Social Security works.

The general idea floating around the populace is that if the government would simply remove the income cap upon which the tax rate is applied, that would solve all the problems and be the most fair solution.

I think it is clear that Social Security taxes will have to go up, but simply raising the cap is not the best way, most fair way, nor mathematically feasible way to accomplish that. Here’s why:

> Income under $110,100 is taxed at 6.2% for each of the employer and employee (it is 12.4% when combined) and benefits are capped up to that level of income.

> For workers whose income (and spending) is above the $110,100, they need to save more (and a greater percentage) of their income to fund their post-retirement lifestyle.

> Contrary to what some folks think, they are not receiving Social Security benefits without contributing to the system (for their income above $110,100) – their benefits are simply capped.

> The Social Security tax is an extremely progressive tax in spite of the fact that it is a flat 12.4% rate. The reason for this is that the benefits which are are credited to you decrease substantially as your income approaches $110,100.

> The first $9,204 of your annual earnings are credited for 90% benefit, the amount of your annual earnings between $9,204 and $64,728 is credited for 32% benefits, and the amount of your annual earnings between $64,728 and $110,100 is credited for 15% benefits.

The result is very apparent in the benefit payments that retirees receive: studies show that lower income workers receive benefits of about 55% of their annual earnings while higher income workers receive about 28% of their annual earnings.

Social Security was never designed to be a retirement plan – it was designed to be a social safety net where higher paid people assist lower paid people avoid poverty during their final years. You can debate whether this is right or wrong from the left or right, but it is just what President Roosevelt intended.

Where we have run afoul of the solvency of Social Security is that originally in 1945, there were 42 workers paying Social Security taxes for each person receiving benefits. Last Fall, the Labor Department reported that that there are only 1.75 workers paying for for each recipient. The math just does not work out to be able to provide all of the benefits that have been promised based upon the projected revenue stream from an ever-dwindling number of tax payers.

In order to fix the Social Security system’s projected under-funding as detailed on the chart above from the General Accounting Office, you will have to play with more than just the income cap – there simply are not enough people earning above the income cap to completely fund the projected deficit, even if you removed the income cap completely.

What you will see at some point – when someone in DC gets brave enough – is some combination of:

> increasing the income cap

> reducing the benefits credit percentages

> reducing the dollar levels at which the percentages drop

> increasing the age at which people are eligible to receive benefits

> increasing the tax rate higher than 12.4%

> changing the inflation index/methodology upon which Social Security benefit increases are calculated.

It is very likely that current and soon-to-be recipients will be grandfathered to some extent – but for those under 55 or 60, there will likely be some major changes in the way Social Security is taxed and pays benefits.

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