Here's How Social Security Collected More Than $1 Trillion in 2018

The newest Social Security Trustees Report is out, and as has been the case for more than three decades, it's time for some nail-biting.

According to the latest report, Social Security managed to buck the 2018 prediction that the program would expend more money than it collects for the first time since 1982. Even though last year's projection from the trustees was for a pretty menial net cash outflow of $1.7 billion, the program wound up producing a net cash surplus of $3.1 billion in 2018. Though multiple factors likely played a role, stronger economic growth is probably the biggest factor that pushed this unwelcome inflection point further down the line.

Unfortunately, this doesn't change the longer-term outlook for Social Security. Namely, it's still facing a very large expected cash shortfall between its new asset-reserve depletion date of 2035 (one year later than last year's report's prediction) and 2093. While the 2017 report forecast a $13.2 trillion cash shortfall between 2034 and 2092, the new report highlights an expected $13.9 trillion shortfall between 2035 and 2093, assuming Congress fails to act. This would necessitate a benefits cut of up to 20% within the next 16 years to keep Social Security solvent over the next 75 years.

But this new data is only part of the story. Perhaps the bigger news from the trustees report is that Social Security collected more than $1 trillion in revenue in 2018 for the first time in its history. Side note: It also spent more than $1 trillion for the first time ever.

How exactly does America's most important social program generate $1,003,400,000,000 in revenue in a single year? Let's take a closer look.

Social Security's saving grace: The 12.4% payroll tax

Although Social Security has three source of funding, they aren't equal in importance. The 12.4% payroll tax on earned income of up to $132,900 in 2019 is by far the most critical piece of the revenue puzzle. In 2018, $885.1 billion of the $1,003.4 billion collected by the program was the result of the payroll tax.

The interesting thing about the payroll tax is that, while it contributes a majority of Social Security's money, it allows quite a bit of taxable income to escape. First, only earned income (i.e., wages and salary paid to you) are subject to the payroll tax, with investment gains exempt.

And second, the payroll tax comes with the aforementioned cap of $132,900 in earned income. Any wages or salary up to this amount are subjected to the tax, while earned income above this amount is exempt. This means that while more than 90% of working Americans pay into the program with every dollar they earn, a small percentage of well-to-do workers will have some of their income exempted from taxation. In 2016, some $1.2 trillion in earned income avoided the payroll tax, thereby denying Social Security almost $150 billion in revenue.

Why not lift or remove the earnings cap on the payroll tax? The twofold answer is that there aren't enough votes in the Senate to do so, and the wealthy are already paying their fair share since a cap also exists on the amount of benefits the program will pay out monthly at full retirement age.

It's also worth noting that most folks aren't paying the full 12.4% tax. If you're employed by someone else or through a company, your employer covers half (6.2%) of your payroll tax liability, and you cover the other half (6.2%). But if you're self-employed or a sole proprietor, you can expect to fork over the 12.4% rate on your earnings, up to the earnings cap.

The program's necessary evil: The taxation of benefits

Social Security's second key funding source is the necessary, but nonetheless hated, taxation of benefits. In 2018, the taxation of benefits led to $35 billion in revenue, down from $37.9 billion in 2017. This slight dip is the result of changes to the U.S. tax code brought about by the Tax Cuts and Jobs Act.

In 1983, the Reagan administration passed the last major overhaul of Social Security, with amendments to the program coming from both sides of the political aisle. One such inclusion was the introduction of taxing Social Security benefits when income thresholds reached a certain point. If a single taxpayer's modified adjusted gross income (MAGI) plus one half of their benefits exceeded $25,000, or $32,000 for a couple filing jointly, up to 50% of Social Security benefits could be exposed to ordinary federal income tax rates. This was first implemented in 1984, and it was estimated to impact about 1 in 10 senior households.

In 1993, under the Clinton administration, a second tier of taxation was added that allowed up to 85% of a person's or couple's benefits to be exposed to federal taxation. The threshold (MAGI plus one half of benefits) was set at $34,000 for an individual and $44,000 for a couple filing jointly, and the rule was expected to impact just under 1 in 5 senior households.

Today, more than 35 years after taxation of benefits began and 25 years after it was expanded, about half of all senior households owe some amount of tax on their Social Security benefits. That's because the income thresholds associated with the taxation of benefits have never been adjusted for inflation. Assuming these thresholds aren't adjusted, the expectation is that more seniors will become exposed to taxation on their benefits as time passes.

The overlooked funding source: Interest income

The third and final source of income for Social Security is the interest it earns on its nearly $2.9 trillion in asset reserves. Asset reserves are the aggregate net cash surpluses that Social Security has accrued since its inception. In 2018, interest income brought in $83.3 billion for the program.

Social Security's asset reserves are often a topic of hotly contested debate. Quite a few Americans believe that lawmakers on Capitol Hill absconded with the extra cash, used it to fund wars, and plan to never return it, leaving future retirees high and dry. Of course, this is far from the truth.

The program's net cash surpluses are invested in special-issue bonds and, to a lesser degree, certificates of indebtedness, as required by law. These interest-bearing tools do allow the government to borrow money, but every dime borrowed is accounted for. What's borrowed by the government also isn't earmarked for any specific line item in the budget. Rather, it can go toward defense spending, education, healthcare, or any number of federal budget items.

Here's the part most folks tend to overlook: The federal government pays interest on what it borrows from Social Security. In March, the program was yielding an average of 2.85% across various bonds and maturities. If the government repaid the borrowed funds, it would mean Social Security would kiss this annual income goodbye.

It's important to note that if the trustees report is correct and Social Security does exhaust its asset reserves by 2035, then this income source will disappear, leaving the two recurring sources of income, the payroll tax and the taxation of benefits, to fund Social Security.

And that, my friends, is how the greatest social program in the United States managed to collect more than $1 trillion in revenue last year.

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