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

Episode Transcript

SPEAKER_00 (00:16):
Can we resolve the Social Security shortfall by
using tax incentives?
Social Security refers to thefederal program OASDI, which is
the acronym for Old Age,Survivors, and Disability
Insurance Program.
It was passed in 1935 inresponse to the Great Depression

(00:38):
as an attempt to reduce thesuffering from poverty and
destitution for those withlittle wealth and were incapable
of generating significantincome.
While helping the poor anddisabled has moral and ethical
imperatives for many, it is alsothe case that by helping them it
bolsters demand for economicproduction as well as freeing up

(01:02):
labor of those who are of primeage by helping older people to
maintain themselves.
Unlike modern retirementaccounts, like IRAs, 401ks, and
403Bs, which are assets thatpeople own, Social Security is a

(01:22):
type of insurance.
FICA payroll taxes are thepremiums employees and employers
pay toward this insurance.
If you are self-employed, youpay both the employee and
employer shares.
The more premiums are paid overone's lifetime, the greater the

(01:46):
benefits to which one isentitled.
Thus, people with higher incomesand paying more payroll taxes
would tend to receive greaterSocial Security payments when
they retire or reach the age formaximum benefits.
As of the year 2025, it is setat 70 years old.

(02:10):
Because it is an insurance,those benefits cease when a
beneficiary dies.
This is very different thanretirement accounts, which can
be transferred as an inheritanceto a spouse, children, or other
recipient.
As an insurance program, whenSocial Security premiums exceed

(02:33):
benefits, the surplus was keptin trust funds.
So earlier on in the program, upuntil about 2009, the trust
funds grew, since the number ofworking-age individuals were
greater than those receivingbenefits.
This was also part of thepreparation for the demographic

(02:56):
shift starting around 2010 whenthe baby boom generation began
retiring in larger numbers.
Since then, the outlays forbenefits have exceeded the tax
revenues, and thus the trustfund began to decrease.
It is estimated that by theearly 2030s the trust fund will

(03:19):
be depleted.
This implies that without anychanges to the tax rates and
income limits, there will not beenough revenues to cover all
entitled benefits.
Estimates are in the range ofabout 75 to 80% of benefits
being paid.
It is important to note thatthis does not mean the program

(03:41):
is bankrupt.
Since it is an insuranceprogram, the finances can be
balanced out by reducing theamount of benefits provided.
Of course, this places theburden on the very people the
program was intended to help, aswell as diminishing
macroeconomic growth.

(04:03):
How to handle this discrepancyis based on how benefits and
burdens are prioritized.
For example, those who weigh theimportance of maintaining
benefits would prefer to seeeither increases in the FICA
rate andor higher limits on howmuch income is taxed.
Of note is that those who areself-employed would experience

(04:26):
double the increase on FICArates than those employed for
someone else.
In recent Pew surveys, about 80%of all Americans state that they
would prefer to keep fullbenefits.
Even three-quarters of thehighest income class supports
this.
However, there is an influentialanti-tax contingent which would

(04:50):
prefer to see decreased benefitsinstead of increased taxes.
Is there a way to minimize theharm from decreasing benefits if
FICA rates and limits remainunchanged?
We will need to consider therelative importance of benefits
by income class.

(05:11):
Based on a 2014 study by theSocial Security Administration,
which looked at relativeimportance for those 65 and
older, the lowest total incomeclass had Social Security income
account for about 84% of theirtotal income.

(05:31):
In the highest total incomeclass, this was about 22%.
In inflation-adjusted dollars,the lowest income is below about
$18,000 a year, while thehighest income is above about
$64,000 a year.
Keep in mind these numbers arefor people who are already

(05:53):
receiving Social Security, somost are retired and have no or
little employment income.
It also highlights a confoundingissue.
Those with the greatest averagebenefits are the ones with the
greatest amount of retirement,investments, and other income.
Thus, if we wanted to minimizethe harm from reducing total

(06:17):
Social Security benefits, anacross-the-board benefit cut of
25% would not be the best wayforward.
Those most reliant on SocialSecurity benefits would be
devastated, while those leastreliant might only be
inconvenienced.
Is there another approach?

(06:38):
Here we can leverage the factthat those with higher income
will tend to pay higher extraincome taxes on those Social
Security benefits.
For example, someone who hasretirement and other income of
$100,000 a year would owefederal income taxes on most of
the Social Security benefits ata marginal rate around 24%.

(07:04):
Thus, after taxes, they arereceiving about 80% of that
benefit.
Those with total incomes belowabout$25,000 a year would pay no
extra income tax.
One possibility is encouragingindividuals to voluntarily

(07:24):
forego some or all of theirSocial Security income.
In particular, those people thatalready have higher income from
investments and retirementaccounts.
This then reduces thegovernment's gap between Social
Security taxes received andSocial Security payments

(07:46):
distributed.
Even if it does not eliminatethe full gap of about 25%, there
would be less harm, for example,from an across-the-board 10%
cut.
There is still a sting fromforegoing Social Security,
except for those families withvery great other income.

(08:08):
A possible incentive is forpeople to receive a federal
income tax deduction equal tothe amount foregone while only
including the Social Securityincome they do receive.
This provides a more significantincentive for those with larger
other income, such as their 401kin investments.

(08:31):
In other words, someone withother income of about$100,000
and is entitled to$50,000 a yearin Social Security benefits
might only be giving up about$25,000 after all the tax
considerations.
Beyond this, relative to thealternative of an involuntary

(08:56):
cut in benefits of 25%, the netforegone benefit would be much
less.
For some higher incomeindividuals with marginal tax
rates of 35% or more, the netforegone benefit would be close
to zero and thus littledisincentive for voluntarily

(09:18):
foregoing Social Securitybenefits.
However, there is an obviouscaveat.
This approach reduces totalfederal income tax received.
This means that some of theSocial Security shortfall is
pushed on to other federalfunding instead.

(09:38):
As economists often say, thereis no free lunch.
It is the fungibility offinances that make this
possible.
Still, from a politicalperspective, it might be more
marketable to those who favorthe use of reducing taxes, and
especially to those that prefervoluntary choices rather than

(10:03):
mandatory actions.
The key to understanding whysuch a voluntary alternative
could be helpful is recognizingthat if greater FICA taxes are
not implemented, then cuts innationwide Social Security
payments will be unavoidable.

(10:25):
It is a reminder that what iseconomically rational does not
exist in a vacuum.
It depends on the priorities andpreferences of decision makers
and stakeholders.
And those priorities andpreferences are not fixed.
They change with politicalfortunes and cultural

(10:46):
developments, which in turn aredependent on the choices we make
today.