Social Security’s Trust Fund is projected to run out in 2034. As policymakers consider restoring financial balance to the program, one topic that may be discussed is how to structure any tax increases. Understanding why Social Security requires a higher payroll tax than a funded retirement program for a given level of benefits is a crucial first step in informing this discussion. The current “pay-as-you-go” approach is the result of the policy decision made decades ago to pay benefits far in excess of contributions for early cohorts of workers. By paying benefits in excess of contributions to early cohorts, the nation essentially gave away the Trust Fund that would have accumulated and, importantly, gave away the interest on those contributions. Thus, the payroll tax must cover not only the required contribution but also the missing interest. This paper addresses alternative ways to pay for this Missing Trust Fund, including a comparison of the size of the required changes and their distributional implications.
This paper found that:
- The size of the OASI Missing Trust Fund is $27 trillion dollars.
- The so-called Legacy Debt – i.e., the $29.3 trillion dollar net transfer to pre-1932 birth cohorts – is the driver of this Missing Trust Fund.
- Paying for the missing interest on this Missing Trust Fund could be accomplished with a permanent increase in the capped payroll tax of 3.7 percentage points, in an uncapped payroll tax of 3.0 percentage points, or in the income tax of 2.3 percentage points.
- Accumulating assets to replace the Missing Trust Fund over 75 years requires larger, temporary increases in those taxes of 6.5 percentage points, 5.3 percentage points, and 4.1 percentage points, respectively.
- The burden of a payroll tax increase tends to fall more on households in the middle two income quartiles, whereas the income tax burden falls more on the top quartile.
The policy implications of this paper are:
- The fact that the primary cause of the Missing Trust Fund is the Legacy Debt suggests that increasing the income tax merits consideration, since paying benefits to early program participants benefited all of society.
- While replacing the Missing Trust Fund would ultimately create a fully-funded system with a large, interest-generating Trust Fund, such a move raises macroeconomic issues and questions of intergenerational equity.
- Finding the right approach merits society-wide discussion.