The “Big, Beautiful Bill” that recently passed the House, Senate, and was signed into law by President Trump temporarily increases the deduction on Social Security income so that upwards of 90% of seniors will pay no income tax on Social Security benefits. This deduction is scheduled to expire in 2028 and benefits middle- and upper-income seniors the most as lower income seniors already do not pay federal income tax.
Economically speaking, it’s hard to justify a special income tax exemption on Social Security income. Middle- and upper-income seniors have had a lifetime to build assets and disproportionately have a higher net worth compared to younger generations who are working, raising families, and paying income tax on their full amount of earnings.
Aside from the Big Beautiful Bill, there are long term concerns about Social Security’s finances, with the Social Security Trust Fund projected to become depleted by 2033. What does it mean if Social Security is insolvent?
Social Security is funded by the Federal Insurance Contribution Act (FICA) tax, which is a 7.65% payroll tax on employers and a 7.65% payroll tax paid by employees. When a worker is paid, revenues from this tax are transferred directly to an existing Social Security recipient. No money is set aside in a savings account for when this worker retires. The idea is that when this worker reaches retirement age, there will be a new worker paying FICA to fund this retiree’s Social Security benefits. Thus, current beneficiaries are paid for by current taxpayers.
The problem with this system is that people are living longer, and the birth rate is falling, so that fewer workers are replacing Baby Boomers who are retiring and thus, fewer people are paying FICA.
The Social Security Trust Fund was supposed to be a buffer against this as it built up assets while the Baby Boomers were working in preparation for their retirement. This trust fund is projected to be depleted by 2033, which is only eight years away.
What happens when this occurs? The law says that benefits will automatically be cut so that benefits equal annual FICA tax revenues. This translates into roughly a one-third benefit cut, meaning Social Security would only pay two-thirds of promised benefits unless Congress changes the law to borrow to cover this difference and add it to the national debt. In my view, this is the likely outcome, which is why the national debt is a significant concern. There is only so much the government can borrow before lenders stop lending it money.
It is important to note that the President cannot unilaterally change Social Security benefits as they are set by law. Changing the benefits formula or FICA tax rate requires an act of Congress unless the Trust Fund becomes depleted. Thus, the Trust Fund’s depletion and the size of the national debt are the real risks facing Social Security. This has been known for decades, but no action has been taken.
