There's little argument that Social Security is a financial pillar for most seniors. Each month, more than 43 million retired workers receive a benefit check, with more than 60% of these retirees leaning on the program to account for at least half of their income.
There's also little disagreement that Social Security is in trouble and needs Congress to fix it.
According to the latest annual report from the Board of Trustees, Social Security is set to hit an inflection point this year that sees more money spent than is collected for the first time since 1982 . Although the amount of money flowing out of the Trust's asset reserves is estimated to be relatively small ($1.7 billion) compared to the nearly $2.9 trillion currently in asset reserves, this net cash outflow is expected to accelerate in the years to come. By 2034, ongoing demographic and economic changes are forecast to have completely exhausted Social Security's almost $2.9 trillion in excess cash. Should this happen, and if Congress fails to act, an across-the-board benefits cut of up to 21% may be needed to sustain payouts through the year 2092.
Image source: Getty Images.
Retired Americans loathe the taxation of benefits
To be certain, there are solutions aplenty that have been proposed by Democrats and Republicans to resolve the estimated $13.2 trillion cash shortfall between 2034 and 2092. But ask the average retired American what he or she wants, and they're liable to retort that they'd like to see the taxation of Social Security benefits done away with. Some 91% of retired Americans favored an end to the taxation of benefits in a survey conducted by The Seniors Center, a Washington, D.C.-based nonprofit organization that looks out for senior interests, last year.
So why doesn't the federal government abide by the will of the people? Frankly, it's because the taxation of benefits has put Social Security between a rock and a hard place.
Who faces this tax, you ask? Single taxpayers whose adjusted gross income (AGI) plus one-half of their benefits exceeds $25,000 and couples filing jointly whose AGI plus one-half of benefits tops $32,000 could have up to 50% of their Social Security payout taxed at federal ordinary income rates. This initial level of taxation was signed into law in 1983 during the last major overhaul of the program by then-President Ronald Reagan.
Image source: Getty Images.
Since then, a second tier of taxation was added in 1993 under the Clinton administration that allows up to 85% of benefits to be taxed. The income thresholds here are more than $34,000 for single beneficiaries and in excess of $44,000 for couples filing jointly. When first implemented in 1984, the taxation of benefits impacted about 1 in 10 senior households. As of 2018, The Senior Citizens League estimates that 56% of senior households are facing some degree of taxation on their Social Security benefits.
The reason for this disparity is simple: The income thresholds noted above haven't once been adjusted for inflation since being introduced. As such, more and more retired workers are becoming subject to some level of taxation on their benefits as income levels have grown.
Stuck between a rock and a hard place
So why not just adjust these income thresholds for inflation -- or better yet, remove the tax entirely and allow beneficiaries to keep their entire benefit? Doing so would, presumably, give more than half of all Social Security recipients a "raise." Even just adjusting the income thresholds for inflation would stop exposing middle-income seniors and couples to taxation.
But herein lies the problem . With Social Security facing a $13.2 trillion cash shortfall between 2034 and 2092 and the program forecast to begin running in the red in 2018, adjusting the income thresholds for inflation or removing this tax entirely means giving up precious revenue -- revenue that simply can't be tossed out right now.
Image source: Getty Images.
As a reminder, Social Security only has three sources of revenue : (1) the 12.4% payroll tax on earned income of up to $128,400 (as of 2018), (2) the taxation of benefits, and (3) interest income earned on its asset reserves. By 2034, assuming the Trustees are correct about the Trust's excess cash being depleted, there will no longer be any interest income flowing into Social Security. If the taxation of benefits were removed, too, it would leave the payroll tax as the sole provider of the program.
Over time, the taxation of benefits is projected to play a larger role in revenue collection. Last year, it was responsible for $37.9 billion of the $996.6 billion collected. By 2027, it's forecast to bring in $88.1 billion of the $1.55 trillion collected that year. As a percentage of revenue collected, and in nominal terms, the taxation of benefits is only growing in importance.
Thus the dilemma: Removing this tax or adjusting it for inflation would provide a short-term boost for existing retirees, but over the long run would cause the program to generate even less revenue and burn through its asset reserves even faster. Chances are that more than a 21% across-the-board cut would be needed to sustain payouts through 2092 without the taxation of benefits.
This tax may be a sore spot among retirees, but it's not going anywhere anytime soon.
More From The Motley Fool
- Here's How to Get the Maximum Social Security Benefit
- The $16,728 Social Security Bonus You Can’t Afford to Miss
- Is Social Security Taxable?
The Motley Fool has a disclosure policy .