One reason Social Security is in fiscal decline.

Here is a more complete analysis of Social Security funding shortfalls and how we got HERE.

Clearly, intentionally, Congress and President CARTER decided, during a period of hyper inflation in the late seventies, to put Social Security on autopilot to trust fund exhaustion, and, President Reagan’s 1983 reforms did not correct the structural defects. It changed Social Security from the base level of benefits as initially intended to something more.

Top Takeaways:

The average Social Security benefit today is about 70 percent higher, in inflation-adjusted terms, than the average benefit paid in 1977.

It’s worth noting that Congress altered Social Security’s benefit formula against the unanimous recommendations of an expert panel created to consider just that issue. The panel argued that adopting a slower rate of benefit growth would allow “future generations to decide what benefit increases are appropriate and what tax rates to finance them are acceptable.”

Various papers have shown that rising health insurance premiums have disproportionately eaten away at the earnings of lower-income employees. As Gary Burtless and Sveta Milusheva stated in a 2012 Brookings Institution study, “because employer health insurance premiums represent a much higher percentage of compensation below the maximum taxed earnings amount, the effect of health cost trends exerted a disproportionate downward pressure on money wages below the taxable maximum, reducing the percentage of compensation subject to the payroll tax.”

And, of course, those people who complain the most and the loudest about the Medicaid and other changes in the “One Big Beautiful Bill” want workers, whose wages are already depressed due to the ever increasing cost of health coverage, to shoulder that cost for others through higher taxes.

From Andrew Biggs:

“… If not for wage indexing, demographic pressures on Social Security would be far more manageable
…

The 2025 Social Security Trustees Report, released on June 18, reports that the Old Age and Survivors Insurance trust fund will be exhausted in 2033. Over the long term, Social Security faces an unfunded obligation that tops $26 trillion. This funding gap is often claimed to be the inevitable result of an aging population or the wealthy escaping their tax obligations. But the real story is more surprising—and more solvable.

A 1977 law that locked in automatic benefit growth has quietly driven the program toward insolvency, while shifts in how compensation is structured and taxed contribute to misunderstandings on the share of compensation affected by payroll taxation. Understanding these dynamics is critical to crafting effective reforms that address the root causes of Social Security’s funding gap.

Two common but misleading narratives

The Trustees Report is complex, but in discussions and reporting on Social Security’s financial challenges, two narratives are common.

The first narrative is that population aging – specifically, a smaller number of workers supporting larger numbers of seniors – is the natural driver of Social Security’s funding shortfall.

The second narrative is that, amidst this aging population, the share of total wages and salaries subject to the Social Security payroll tax has declined, from about 90 percent in 1983 to only 83 percent today. This change, it is argued, has allowed the wealthy to escape paying their fair share while Social Security’s finances suffer the cost.

Both narratives are true in the technical sense that Social Security’s Trustees and actuaries examine these questions.

But neither narrative tells the full story about how Social Security’s financial challenges arose and what policymakers might do to address them. And once the full story is recognized, the argument for simply raising taxes to keep Social Security is weakened.

Embedding economic growth as a key driver of benefit growth

The US population is indeed aging, due to both lower birth rates and longer life expectancies. As a result, the number of workers per Social Security beneficiary has declined, from 3.2 in 1977 (more on that date later) to 2.7 today. The Trustees project that by 2050, there will be just 2.2 workers per beneficiary.

But one fact is ignored: because real wages have been increasing, smaller numbers of workers could still support a larger number of retirees if those retirees’ benefits weren’t increasing at the same rate as wages. And, for most of Social Security’s history, that’s how the program worked.

From Social Security’s inception in 1935 up until 1977, Social Security benefits were increased on an ad hoc basis. In nine of 13 Congressional sessions from 1950 to 1975, Social Security benefits were boosted – and not merely through cost-of-living adjustments after retirement, but also the initial benefits when a person first retires. Benefits were increased as-needed and as-affordable, with Congress considering the adequacy of benefits as well as the other financial demands on the federal government.

But in 1977, Congress enacted and President Jimmy Carter signed a major change to the Social Security benefit formula. The 1977 Social Security Amendments put the benefit formula on autopilot, dictating that the initial benefits received in retirement would increase from year to year at the rate of national average wage growth. As a result, the average Social Security benefit today is about 70 percent higher than the average benefit paid in 1977, even after adjusting for inflation.

The average Social Security benefit today is about 70 percent higher, in inflation-adjusted terms, than the average benefit paid in 1977.

This approach, called “wage-indexing,” largely took economic growth out of Social Security’s funding equation. If the economy grows faster, wages grow faster and payroll tax revenues grow faster—but not long after, benefits start to grow faster as well. Wage indexation of initial benefits is why even sky-high rates of economic growth would not keep Social Security solvent.

But this was a policy choice: demographics didn’t have to be the main driver of Social Security’s costs. It was Congress in 1977 building economic growth into the benefit equation, that ensured demographics were all that was left.

It’s worth noting that Congress altered Social Security’s benefit formula against the unanimous recommendations of an expert panel created to consider just that issue. The panel argued that adopting a slower rate of benefit growth would allow “future generations to decide what benefit increases are appropriate and what tax rates to finance them are acceptable.”

Had the pre-1977 approach continued, Social Security would almost certainly be solvent today. Congress, ensuring that Social Security benefit costs would stay roughly in line with tax revenues, would have made its discretionary benefit increases just slightly smaller than the automatic rate that is now embedded in the program’s benefits.

But, by effectively giving away its power to adjust the growth rate of future benefits until a funding crisis was nigh, Congress made demographics destiny. And, in the process, has practically guaranteed that such a crisis will occur.

…

Social Security is funded via a 12.4 percent tax on earnings up to a specified cap, which in 2025 is $176,100. Participants pay taxes on earnings up to $176,100, and their benefits are calculated on those same capped earnings.

In 2023, the Social Security payroll tax was applied to 83 percent of total earned income. But back in 1983, 90 percent of total earnings were taxed.

Seemingly, this is a rich-get-richer kind of story where the wealthy avoid paying their fair share, denying Social Security of revenues that could pay benefits and put off insolvency.

And, to address it, many believe it is common sense to increase or even eliminate the ceiling on wages subject to payroll taxes. Restoring Social Security’s taxes to cover 90 percent of total earnings would require the payroll tax ceiling to rise to about $350,000. For workers in this income group, it would be a substantial increase in their taxes.

But there’s more to this story than the rich getting richer. In fact, income inequality, as we typically think about it, plays a much smaller role than one might presume, for two reasons.

First, the 1986 Tax Reform Act altered tax rates and regulations such that it made sense for so-called S Corporations to report income as wages paid to employees rather than dividends paid to shareholders (who were, in fact, the same people as the employees). As a result, reported wage income increased, and by enough to matter. In Congressional Budget Office data, the top 1 percent of households received 30 percent of their total incomes via earnings in 1985. By 1992, their earnings share of total income had risen to 42 percent. These newfound earnings weren’t taxed by Social Security, as they were above the payroll tax ceiling.

Now, in a sense that didn’t matter: that income wasn’t taxed before, either. But once that income began being reported as wages, it reduced the share of total earnings hit by the Social Security tax and created the rich-getting-richer narrative, even if income inequality didn’t change.

There’s a second factor that reduces the share of earnings covered by the Social Security tax: rising premiums for employer-sponsored health insurance. Specifically, when the premiums that employers pay for their employees’ health insurance increase, employers tend to cover those costs by reducing the growth of their employees’ wages. That reduces employees’ salaries subject to Social Security payroll taxes. In addition, the premiums that employees pay toward their workplace health plan also typically are not taxed by Social Security.

Okay, but how does this affect Social Security? The reason is that employer-sponsored health insurance premiums are larger relative to salaries for lower-paid than for higher-paid employees. Let’s say that an employer currently pays $10,000 per year for health premiums, but then the cost rises to $12,000 per year. To keep himself whole, the employer reduces every employee’s salary by $2,000. For an employee earning $20,000 annually, this reduces his pay by 10 percent. But for an employee earning $200,000 per year, his pay is reduced by only 1 percent.

This isn’t just theory. Various papers have shown that rising health insurance premiums have disproportionately eaten away at the earnings of lower-income employees. As Gary Burtless and Sveta Milusheva stated in a 2012 Brookings Institution study, “because employer health insurance premiums represent a much higher percentage of compensation below the maximum taxed earnings amount, the effect of health cost trends exerted a disproportionate downward pressure on money wages below the taxable maximum, reducing the percentage of compensation subject to the payroll tax.”

To address the role of health premiums in reducing Social Security’s funding base, one option would be to make premiums subject to the payroll tax. One such policy analyzed by Social Security’s actuaries would address about one-third of the program’s long-term funding gap. While it would increase taxes, in particular on low earners, low earners also receive back more in Social Security benefits than they pay in taxes. In other words, while many would not be happy in the short term, in the long term, low earners would actually be made better off.

So what does all this add up to?

First, the cause of Social Security’s $26 trillion long-term funding gap isn’t simply demographics. It’s demographics coupled with a policy, enacted over 40 years after the 1935 Social Security Act was passed, that automatically increases future benefits in line with wage growth, which historically tends to exceed the rate of inflation. Congress can’t (easily) change demographics, but it sure can change policy.

And second, the idea that Social Security’s funding has been undermined by letting the rich off the hook for their obligations has a remarkably weak basis in fact. Two factors that have nothing to do with income inequality – a tax law-induced shift in how income is reported and the rising cost of employer healthcare premiums (and their exclusion from the taxable base) – likely account for most of the decline in the share of earnings subject to Social Security taxes.

Social Security is the federal government’s largest spending program, the largest tax most American workers pay, and the largest source of income for most retirees. And it’s over $26 trillion in the financial hole. Lawmakers should revisit whether automatic wage indexing remains appropriate in today’s fiscal environment. They should also consider whether certain forms of compensation, like employer-sponsored health insurance premiums, should be included in the taxable base. Most importantly, they should reject the idea that tax hikes alone are the logical means to save Social Security—and consider structural benefit reforms before time runs out.

At the very least, it’s crucial that Americans and their elected representatives have an accurate picture of the forces and policies that are leading Social Security toward insolvency. …”

Emphasis added by BenefitJack

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