The tax cuts ignore this impact on Social Security's finances

Social Security gets some revenue from income taxes — and unlike payroll taxes, it doesn't come with promises to future beneficiaries.

  • By Brenton Smith,
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The issue of Social Security is nearly invisible in the eye of the voter these days. Congress has just approved a massive tax reform without even a word about how it will affect the long-term financial prospects of the nation's social insurance programs.

Typically, even critics of the GOP's ideas on tax reform limit their concerns to the possibility that rising budget deficits might force Congress to consider reductions to benefit levels in Social Security. To them, the connection between tax reform and Social Security is a matter of politics and priorities.

Make no mistake, the connection isn't political. It is economic. Social Security draws revenue from the income taxes levied by the IRS on benefits. Medicare also collects money. Thus, meaningful tax reform particularly for those in the middle class is apt to add to the financing pressures of both.

Income-tax revenue is important to Social Security because it is free cash flow that is forecast to grow rapidly. In the latest trustees' report, the authors projected that the system would gather about $35 billion in revenue from income taxes in 2017. While this sum is currently overshadowed by payroll tax revenue, income-tax support for Social Security is projected to grow at more than three times the rate of the economy to more than $80 billion over the coming decade. That figure approximates the payroll taxes of roughly 20 million active workers.

This tax primarily hits the middle class because the levy applies to people with income as low as $25,000, including part of what they get from Social Security. With every dollar of income earned above the threshold, the rules expose more benefits to taxation. By the time a senior has earned $75,000, 85% of his or her check is taxable. If the tax rate for these individual falls, Social Security and Medicare will get less money in income taxes.

Less money going into these programs translates into reaching insolvency faster, and generating larger benefit cuts over time.

Not all dollars are the same

In response, supporters will tell you that tax cuts will lead to economic growth, leading to more taxpayers earning higher wages. It is possible.

The argument ignores, however, two visible differences in the dollars collected. The income-tax revenue is free cash flow whereas payroll-tax revenue generates program costs in the form of higher benefits when workers become beneficiaries. Moreover, the benefit formula will translate any higher wages into higher benefits immediately.

Sizing up your Social Security check

What benefits you should expect.

We can't replace free cash with money that is effectively a loan from future retirees.

The discerning eye is looking for the bottom line. There isn't one. It appears that no one has asked either the Social Security Administration or the Congressional Budget Office to provide estimates. Is the impact billions or trillions? I am not in a position to guess. In fact, the change to Chain-CPI would make this revenue source rise as income tax brackets more move slowly. The point is that we ought to ask.

This isn't the first time that Social Security has lost its place in the national agenda. While no one talked about the connection, the repeal of the Affordable Care Act ("ACA") would likely have cost Social Security about $1 trillion of solvency in the annual forecast as the trustees of the Social Security Trust Funds backed out the more favorable wage assumptions associated with that health-care legislation.

In short, the passage of the ACA led the trustees to assume that employers would increase the portion of compensation paid in taxable wages. These changes were a substantial benefit to the system back in 2010. It only makes sense that trustees would return the assumptions back to their original numbers if we abolish the ACA.

Of course, billions and even trillions of dollars lose focus in the big picture when the total revenue shortfall is $12.5 trillion. Numbers this large raise the question: why should anyone worry about $1 trillion more?

The answer is: because the trend is alarming. Over the past 15 years, the shortfall has grown roughly 9.5%, or roughly three times faster than the economy. As worrisome as that comparison should be, the rate of growth is accelerating. After 40 years, the Social Security had a shortfall of roughly $2 trillion. Over the next two decades, the liabilities nearly doubled to $3.7 trillion. In just the last five years, the system has reproduced that sum.

Complacency about Social Security

Over the last 30 years, voters have grown virtually immune to the trustees' warnings about the deterioration in the program's stability. Even experts have grown comfortable with the steady decline of the program's finances. Last year, a 10% increase in the program's liabilities drew almost no coverage.

The widely ingrained perception that Social Security can function unchanged for decades has reduced the program to the stepchild of politics. In years of discussion about the repeal of the ACA, the impact on Social Security wasn't mentioned. It now seems unlikely that even critics of tax reform will look at how this legislation will alter the health of any of our social insurance programs.

While tangential impact on Social Security can't take complete control of the nation's legislative agenda, the program deserves a level of visibility that suggests that the subject has some meaning to voters. Today the program gets none.

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