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The Business Edge
The Business Edge
Can We Handle The Social Security Shortfall By Using Tax Incentives?
Speaker Bio
Dr. David Axelrod received his Ph.D. in Economics from Rutgers University in 1990. He worked in finance for twenty years as an economist, consultant and actuarial analyst, including positions with Falcon Management, Volvo Finance, and Crum & Forster. He has also produced research in health economics, and on the nature of choice and well-being. Dr. Axelrod then started teaching at Montclair State University in 2013. His book "Nomics: Notes from the Economics of Time, Mind, and Spirit" was published in 2025. Dr. Axelrod provides holonomic consultation and workshops. He also plays electric bass, and has released over a dozen albums of original music
Can we resolve the Social Security shortfall by using tax incentives? Social Security refers to the federal program OASDI, which is the acronym for Old Age, Survivors, and Disability Insurance Program. It was passed in 1935 in response to the Great Depression as an attempt to reduce the suffering from poverty and destitution for those with little wealth and were incapable of generating significant income. While helping the poor and disabled has moral and ethical imperatives for many, it is also the case that by helping them it bolsters demand for economic production as well as freeing up labor of those who are of prime age by helping older people to maintain themselves. Unlike modern retirement accounts, like IRAs, 401ks, and 403Bs, which are assets that people own, Social Security is a type of insurance. FICA payroll taxes are the premiums employees and employers pay toward this insurance. If you are self-employed, you pay both the employee and employer shares. The more premiums are paid over one's lifetime, the greater the benefits to which one is entitled. Thus, people with higher incomes and paying more payroll taxes would tend to receive greater Social Security payments when they retire or reach the age for maximum benefits. As of the year 2025, it is set at 70 years old. Because it is an insurance, those benefits cease when a beneficiary dies. This is very different than retirement accounts, which can be transferred as an inheritance to a spouse, children, or other recipient. As an insurance program, when Social Security premiums exceed benefits, the surplus was kept in trust funds. So earlier on in the program, up until about 2009, the trust funds grew, since the number of working-age individuals were greater than those receiving benefits. This was also part of the preparation for the demographic shift starting around 2010 when the baby boom generation began retiring in larger numbers. Since then, the outlays for benefits have exceeded the tax revenues, and thus the trust fund began to decrease. It is estimated that by the early 2030s the trust fund will be depleted. This implies that without any changes to the tax rates and income limits, there will not be enough revenues to cover all entitled benefits. Estimates are in the range of about 75 to 80% of benefits being paid. It is important to note that this does not mean the program is bankrupt. Since it is an insurance program, the finances can be balanced out by reducing the amount of benefits provided. Of course, this places the burden on the very people the program was intended to help, as well as diminishing macroeconomic growth. How to handle this discrepancy is based on how benefits and burdens are prioritized. For example, those who weigh the importance of maintaining benefits would prefer to see either increases in the FICA rate andor higher limits on how much income is taxed. Of note is that those who are self-employed would experience double the increase on FICA rates than those employed for someone else. In recent Pew surveys, about 80% of all Americans state that they would prefer to keep full benefits. Even three-quarters of the highest income class supports this. However, there is an influential anti-tax contingent which would prefer to see decreased benefits instead of increased taxes. Is there a way to minimize the harm from decreasing benefits if FICA rates and limits remain unchanged? We will need to consider the relative importance of benefits by income class. Based on a 2014 study by the Social Security Administration, which looked at relative importance for those 65 and older, the lowest total income class had Social Security income account for about 84% of their total income. In the highest total income class, this was about 22%. In inflation-adjusted dollars, the lowest income is below about$18,000 a year, while the highest income is above about$64,000 a year. Keep in mind these numbers are for people who are already receiving Social Security, so most are retired and have no or little employment income. It also highlights a confounding issue. Those with the greatest average benefits are the ones with the greatest amount of retirement, investments, and other income. Thus, if we wanted to minimize the harm from reducing total Social Security benefits, an across-the-board benefit cut of 25% would not be the best way forward. Those most reliant on Social Security benefits would be devastated, while those least reliant might only be inconvenienced. Is there another approach? Here we can leverage the fact that those with higher income will tend to pay higher extra income taxes on those Social Security benefits. For example, someone who has retirement and other income of$100,000 a year would owe federal income taxes on most of the Social Security benefits at a marginal rate around 24%. Thus, after taxes, they are receiving about 80% of that benefit. Those with total incomes below about$25,000 a year would pay no extra income tax. One possibility is encouraging individuals to voluntarily forego some or all of their Social Security income. In particular, those people that already have higher income from investments and retirement accounts. This then reduces the government's gap between Social Security taxes received and Social Security payments distributed. Even if it does not eliminate the full gap of about 25%, there would be less harm, for example, from an across-the-board 10% cut. There is still a sting from foregoing Social Security, except for those families with very great other income. A possible incentive is for people to receive a federal income tax deduction equal to the amount foregone while only including the Social Security income they do receive. This provides a more significant incentive for those with larger other income, such as their 401k in investments. In other words, someone with other income of about$100,000 and is entitled to$50,000 a year in Social Security benefits might only be giving up about$25,000 after all the tax considerations. Beyond this, relative to the alternative of an involuntary cut in benefits of 25%, the net foregone benefit would be much less. For some higher income individuals with marginal tax rates of 35% or more, the net foregone benefit would be close to zero and thus little disincentive for voluntarily foregoing Social Security benefits. However, there is an obvious caveat. This approach reduces total federal income tax received. This means that some of the Social Security shortfall is pushed on to other federal funding instead. As economists often say, there is no free lunch. It is the fungibility of finances that make this possible. Still, from a political perspective, it might be more marketable to those who favor the use of reducing taxes, and especially to those that prefer voluntary choices rather than mandatory actions. The key to understanding why such a voluntary alternative could be helpful is recognizing that if greater FICA taxes are not implemented, then cuts in nationwide Social Security payments will be unavoidable. It is a reminder that what is economically rational does not exist in a vacuum. It depends on the priorities and preferences of decision makers and stakeholders. And those priorities and preferences are not fixed. They change with political fortunes and cultural developments, which in turn are dependent on the choices we make today.