Retirement

Social Security taxes are just another tax

Because Social Security taxes are a payroll tax based on our earnings many people see this tax differently from other taxes. It is even perceived by many Americans that they are contributing to an account identified for their benefit.

The following is a common attitude:

“These are not payments, but ‘repayments’ of money that we have been forced to hand over to the government to fund a Ponzi scheme during our working lives. It is not expenditures on the elderly — it is a partial refund of money we have been forced to hand over.”

In fact, this tax is no different than the income tax withholding taken from our pay.

There is no relationship between the taxes you pay and the benefits you may receive. The benefits are governed by law and the law can be changed (and has been) many times. For example, it was recently proposed to increase a factor (bend point) in the formula to increase benefits for lower income Americans.

There are many situations where the Social Security benefit varies greatly from that which could be supported by the taxes an individual paid. For example:

🤫 A worker marries a year before retirement and the family benefit jumps by 50%

🤫 A worker is married ten years or more gets divorced and remarries; two spouses then collect a spouses benefit.

🤫 A worker becomes disabled early in life or dies and family benefits are paid.

🤑 COLAs are paid throughout retirement.

🤑 The benefit formula is intentionally skewed to provide a higher proportional benefit to lower income workers.

Even more telling is the fact that Social Security is not sustained by payroll taxes. First, overall funding is inadequate. The system at current benefit levels cannot be sustained without changes. In addition, benefits can only be paid today using interest on the trust fund bond holdings. Income taxes paid by some individuals on 50% of their benefit are also used by Social Security.

In 2020 the Trustees anticipate starting to redeem the bonds held in the trust.

Think of Social Security like health insurance and Medicare. A group of people pay into a pool; some collect a lot in return, others little or nothing, but in no case is the return related to the premiums (taxes) paid. Of course, with health insurance we hope to collect nothing in return.

Many people hold the view that paying Social Security taxes is a bad deal, that they could invest the money over their working years for a better return. In theory that could be true if everything worked out perfectly over one’s lifetime. However, that logic reinforces the false notion that we pay Social Security taxes only for our benefit in retirement.

To receive the average Social Security benefit today (about $1,300 a month) you would need an income in 2019 of $50,000 before retirement according to the SSA Quick Calculator. To buy a joint and survivor annuity providing that monthly benefit you would need $226,126 according to the Schwab annuity calculator.

Could a person earning $50,000 only at the end of a working career at age 66 accumulate that sum guaranteed? Maybe, maybe not and that’s the difference, the maybe not part. Then there is the second issue. Could that person manage their accumulated retirement fund the generate the monthly income for life … and we haven’t even considered survivor benefits.

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19 replies »

  1. Let’s consider these two statements:

    “In fact, this tax is no different than the income tax withholding taken from our pay.”

    and,

    “In addition, benefits can only be paid today using interest on the trust fund bond holdings.”

    Now, please answer: Where do you think the money comes from to pay the interest on those “trust fund bond holdings”?

    And then, after that: Why do you keep writing about the “trust fund” as if it matters even a whit as to the financial health of Social Security? In doing so, you are perpetuating a gigantic lie about Social Security.

    To your broader point, I think you also could have mentioned that citizens have no legal claim to Social Security at all (Flemming vs. Nestor). The taxes they paid into the system aren’t being held in a “trust fund” on their behalf.

    It’s just another welfare program. It’s dressed up as a retirement system, but perversely this welfare program disproportionately taxes the young and poor (who work and pay the regressive tax, in full) to the benefit of the old and the well off (who live to see the benefits).

    It’s an absolutely idiotic system that only could have been dreamed up in a place like Washington DC.

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    • As you know the interest comes from taxpayers or the deficit just like all federal debt. Yes, the trust is accounting but the fact it’s their and holding bonds paying interest matters a lot. The trust is simply a creditor of the US. Next year bonds will start being redeemed to pay benefits. Where will govt get that money.., more debt. The question is where else could excess tax revenue been placed to earned a guaranteed return, as modest as it is?

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      • I’m sorry, but this is baffling to me.

        You agree that, trust fund or no trust fund, the revenue for benefits would have to come from the same exact sources: either taxation or debt (which is just more taxation later). And yet, in the next breath you say it matters a lot! So, it simultaneously makes no difference at all and yet matters a lot?

        To answer your question about where else the excess revenue could have gone: ideally, it would have been refunded to taxpayers or never taken in the first place. Then, they could have spent their own money on their own desires rather than the desires of those in Washington DC. Imagine that!

        Or, they could have actually invested the money. What does that mean? It means they could have used their earnings to build capital. Capital is what makes us more productive. It makes it easier to grow food, transport things, manufacture things, etc, etc, in the future. That’s what economic growth is. It’s what lets you have more with less effort. But, the key is the postponement of consumption today in favor of building capital (buildings, trucks, R&D, etc). It’s that capital that would make future taxpayers in a better position, financially, to pay for future benefits via taxation. (Or, ideally, have an actual property claim on their own investments).

        Social Security’s setup, today, is a lie. There’s no meaning at all to the trust fund. There’s no saving in the system. There’s no deferred consumption. The government spent the excess money and then has the audacity to claim that it saved it via this phony fund.

        You are perpetuating that lie.

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      • Let’s put it this way. Let’s say you set up your own trust with $1,000 and then bought US Savings bonds. Is the trust real? Do you have anything but a bunch of paper IOUs? Your trust and the SS trust have put their trust in the credit of the federal government with nothing but a promise to pay. As far as investing ones own in lieu of paying taxes goes. Good in theory, but for 99% of Americans never in practice. No discipline and too many variables along the way to retirement.

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      • The difference between me setting up a trust with government bonds and the government setting up a “trust” with government bonds is huge!

        The proper analogy to what the government is doing would me taking money that I have, buying IOUs from myself (that I, myself, will pay back), spending the money, and then claiming that I saved it because of those IOUs. Surely, you see how silly that is?

        One key difference is that government bonds, or corporate bonds, or whatever are backed by other people’s cash flow, not my own and that flow is valued by the market. Other people are on the hook for providing it, not me and the market will just and price their ability to do that, accordingly.

        I’m constrained in my ability to put other peoples promises in my trust by my ability to pay for them. In other words, I defer my consumption. In the other case, I can “save” as much as I want without deferring anything, which I hope we agree isn’t saving at all.

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    • While there are some, how do you conclude that the old are well off when SS is the sole or major source of their income? As far as regressive tax goes, the benefit calculation is designed to pay a higher benefit for the lower income

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      • I didn’t say all old are well off. That’s certainly not true.

        But, if you look at the big picture demographics, by definition the people that get the most benefits are the ones that live the longest. And, the well off tend to live longer.

        In very coarse terms, we’re taxing young minority males to the benefit of old white women. The former work at a young age, pay into the system, and die before getting much out of it while the latter cease working at a young age (if at all) and then live a long time. As I said, that’s a crude picture, but it does get the big demographic picture correct.

        The benefit calculation isn’t what makes the tax regressive.

        What makes it regressive is that fact that the tax hits low income earners disproportionately more (because it’s a flat tax with a cap) and, then, as a final kick in the teeth, low income earners don’t live long enough to see the benefits.

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    • I am 63 and started my SS benefits at 62. I made just $300,000 during my work years. So, I am one of the working poor you are talking about. I will have everything that was paid in FICA taxes by myself and my employers back in just 67 months and I even adjusted the amounts to 2018 dollars. The SS system is one of the best programs that our government has ever come up with. It has kept families out of poverty for over 75 years. It pays benefits of over 800 billion to retirees every year. The taxes that each worker and employer pays, covers disability, survivors and spousal benefits. When I was a young 23 year old I thought I will never see anything from the SS system, but here we are 40 years later and I am collecting a SS benefit. There is no guarantee that the FICA tax paid by employers would of been paid to workers in extra income or that workers would of invested the FICA taxes not paid to the government. I do agree that it is a welfare program for retirees, but without the SS system the government would have to make welfare payments to the poor retirees from some kind of taxing program. What kind of better system would you come up with that would pay – About 62 million people, or more than 1 in every 6 U.S. residents, collected Social Security benefits in June 2018. While older Americans make up about 4 in 5 beneficiaries, another one-fifth of beneficiaries received Social Security Disability Insurance (SSDI) or were young survivors of deceased workers.

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      • A better system? How about a system that won’t collapse in 30 years? You’re 63, congratulations. You’re at the top of the pyramid. When you paid into the system, there were like 30 workers per retiree. Now, there are like 3 workers. When I retire — if I can ever retire — it might be 1:1. That ain’t gonna work.

        No doubt, the system worked great for you. All Ponzi schemes work well for the ones that get in early. You got in early. Good for you.

        I’m not opposed to a poverty program for the poor elderly. It might be true that the “SS system is one of the best programs that our government has ever come up with”, but that’s only true because everything else they come up with is an immediate failure. This is a failure in slow motion. You’re lucky that even if you live to a ripe old age, you’ll die before it dies.

        But, your children and grandchildren will have paid into a system to support you that won’t be there for them. Still think it’s a great program?

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    • Tommy – I am posting here because I cannot reply under your reply to me. The system with a few adjustments will not collapse in 30 years. The Social Security trustees report say it will have enough money to pay 75 % of projected benefits for the next 75 years. As current retirees die their benefits stop. The number of future retirees will be less than the baby boomer generation, unless you count illegal immigration and those workers do not qualify for Social Security benefits. So stop all the negative ponzi scheme talk, benefits of some kind will be there when you retire, will they be as much as they are today, maybe, maybe not. but there will be something even if the government has to tax non profit organizations by then, which I think they should do, to the benefit all citizens.

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      • Well, you don’t know that the number of future of retirees will be lower. Life spans are increasing. That, combined with fewer children being born, is toxic to a paygo system like Social Security.

        I just read that there will be more people over the age of 65 than under 18 in the not too distant future. We’re approaching the point where there’s 1 worker, perhaps fewer, per retiree. How’s that going to work?

        I called it a Ponzi scheme because it gives the illusion of real investment returns, when in reality it’s achieving those “returns” simply by taking more from people at the bottom of the pyramid (e.g., when Social Security started, the total tax was like 2%with a very low cap — now it’s 13%. It’s never been reduced). And, that has to continue with each iteration. If you do that kind of thing in the private sector, you get prosecuted. The system is so poorly designed that it is in trouble less than 100 years after its creation.

        Even accepting the (IMO) optimistic case that future retirees will only get a 25% haircut, it’s hard to sell that as “one of the best programs” ever. For you, sure. For the earliest workers, even better. For me? For my kids? Not a very good deal, at all.

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      • The program actuaries take all those factors into consideration and the demographic factors change over the years such as the life expectancy at age 65 increasing. The program was designed to be insurance and by definition that means some losers and some winners. There were not supposed to be investment returns except as is the case with the reserves being used to buy special treasury bonds. The taxes should have been changed gradually over the years as the factors changed, but Congress has failed to do what the trustees have been calling for the last decade or so.

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  2. I keep reading that social security is running out of funds but there’s plenty of money for illegal immigration health care, education, food stamps, etc….definition of insanity !!

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  3. “The benefit formula is intentionally skewed to provide a higher proportional benefit to lower income workers.”

    That is why I am for having minimum wage indexed to inflation, just like many states do today. Employers with low wage workers are getting a big break in what they pay in FICA taxes per worker. While they continue to have billions of dollars in profit each and every year. Maybe the federal government should change the FICA tax, to an increased percentage per low income worker, then it would balance the SS system. Minimum wage has been indexed to inflation in Montana since 2008 and the minimum wage is at $8.50. All the business owners in 2007 cried – businesses will close – unemployment will go up – prices will go way up, guess what none of that happened. We now have more stores opening every year in my city of 60,000. We even have a second Walmart adding 300 jobs. So, an increase in minimum wage has not stopped investment in my city, sure they may not be making as much profit, but if they do not have a store open in my city they will make nothing from our shoppers.

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    • $8.50 is not significant to make a big impact, jump to $15 and see what happens to prices. I’m sure prices have compensated to some extent. A small business owner is not going to be the only one footing the bill. Billions in profit don’t mean much, what is the profit margin? What investment did it take to make that profit?

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      • When you raise minimum wage it raises the wage floor and more is paid into SS on average wages. I am not saying that you move minimum wage from $7.25 to $15 per hour in one year, but $7.25 in 2009 had the buying power of $8.79 in 2019 dollars. Minimum wage in 1968 when it had its most buying power adjusted for inflation would be $12.79 today. One study showed that McDonald’s could pay $15 per hour by just raising value meal prices $1. Why is it people are against paying low wage workers more? A friend of mine worked as a waitress all her life and when she asked for a raise was told no, you get tips. I know life is not fair, but I will not agree that the owner of all 3 McDonalds in my city could not pay more than $8.50 per hour. I am sure if Montana’s minimum wage was still $725, that is all he would pay. When my daughter started working for him, right out of high school in 1998 all he paid was minimum wage, she worked for him, for 12 months and then started working at the local Walmart for $2 above minimum wage. She served 5 years in the US Army and now sells from home and makes even more. But not everyone has the aptitude to do it. Just the small increase in wages since 2017 has allowed the SS trust fund to meet SS payments without cashing any of the bonds, yet.

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      • When Henry Ford started paying his famous $5.00 a day local merchants quickly raised prices thus negating the increase so Ford started his own lower cost stores for workers. The point is that no matter how the minimum wage is increased, people in those jobs will gain nothing because they will be treading water as costs around them adjust. I calculated what the MW should be adjusted for inflation from several starting years and came up with $11.40 as most likely. But the point is there will be no real benefit to raising the minimum wage in the long run. The only real success will be getting out of that minimum wage job and by the way, relatively few heads of households are earning minimum wage. One final point; pay compression. All those workers now earning above the minimum wage, say $9.00, $10.00, etc will also be seeking an increase adding more pressure to prices.

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      • JRATT – under your waitress tip scenario, if a waitress works for tips that are a percentage of the bill, then as the cost of inflation raises food prices, menu prices would raise, and the overall dining out bill will raise. Therefore if it costs more to eat out in 2019 than it did in 2009, her exact same tip, say 10% would be much larger in 2019. Of all the minimum wage workers, waitress income is already index to inflation.

        If you want to raise the minimum wage, restrict the labor supply of unskilled labor. Not to make this an immigration debate, but roughly there are slightly less than 4 million babies born in the USA. Last month, ICE stopped 144,000 at the border and nobody knows how many got through. The current attempt rate is about 1.7 million illegals trying to get into this country or almost have of the US birth rate. Now, I know that 1.7 million did not make it into the US but this has been happening for decades. Of those 4 million US babies which become unskilled workers later in life, they are now competing for those minimum wage jobs against all those illegals. Businesses illegally hire these illegal immigrants because they will work for any wage just to get money. US citizens are used to getting government welfare or unemployment checks and will not takes those low paying jobs. Inbetween, is everybody else trying to make a living, honestly, and are stuck with a low minimum wage.

        I am not saying that neither the illegal immigrant or your waitress friend do not work hard. They do deserve a living wage. But raising the floor on wages will cause all wages to rise and prices will rise to match. The small boats will rise with the tide, to get a bigger boat, you need more skills. Or in a waitress case, get out of the local dinner and into 5 star restaurant where meals cost more, the wait staff is exceptional and thus the tips better. But there are only so many 5 star restaurants, where the supply meets the demand.

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      • What my waitress friend observed was the prices of meals went up when the owners cost went up and he raised prices, so he made the same profit and her tips went down as the total bill went up; because not everyone tips 10 to 15 percent or anything at all. I would like to see tipping stopped and the price of the meal include the 15% increased wage, so more would be paid per worker into the Social security system.

        My experience is that employers almost never pay what a worker is really worth. I had 3 years experience doing car repairs. The company I worked for closed because the owner retired. I applied for a job at another repair shop and when I wanted to be paid above minimum wage the owner said all I have to pay you is minimum wage. The next day I enlisted in the USAF, served 20 years and never looked back. When I left the USAF at age 40 I had employers tell me, well you have a military retirement, so I am not going to pay you $$$, do you want the job or not. So, I retired at 50 and used debt to fund my lifestyle. Something I would not tell anyone to do. At 62 I started SS benefits and the first 18 months of SS benefits has been used to pay off the debt. I am now in a financial position to save all my SS benefit and my wifes small spousal benefit. I would of not been able to do this if I lived in a high cost of living area.

        I do not think minimum wage needs to be $15 per hour in Montana, but CA, NY, WA, NJ IL and other high cost of living places it sure does. At least it should be indexed to inflation so people who have to work at low wage jobs do not fall further behind. Prices go up all the time for different reasons, we make choices every day where to spend our money, if I want to eat out I am going to pay what it costs and leave a 15% tip, but not everyone leaves tips.

        I agree that as long as we have illegals doing jobs at lower wages the job market wage rate is held low, that is a prime reason to index minimum wage to inflation. If retirees on SS get a COLA then minimum wage workers should get a COLA also.

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