Social Security Faces a Crisis, but Sound Tax Policy Can Help

Social Security, one of the most successful anti-poverty programs in US history, faces a funding crisis by 2035. Raising taxes on upper-income earners and including investment income in the taxable base for Social Security would be practical and politically plausible solutions ahead of this deadline.

The economic stability offered by the Social Security program shouldn’t be imperiled simply because the threat is a decade away. The looming shortfall demands urgent action, and taking steps sooner to increase funding would pay dividends for future generations of retirees and people with disabilities.

The incoming Trump administration and Republican-led Congress ran on a broadly pro-Social Security platform, vowing to protect benefits. These commitments may suggest a political appetite for reforms to secure Social Security’s future.

There are two effective and politically achievable solutions to the funding crisis: raising the cap on taxable income and expanding the Social Security tax base to include investment income.

Eliminating the taxable income cap is one of the simplest and most effective ways to immediately bolster Social Security revenue. As of 2024, the cap is set at $168,600, which means any income earned above that amount is exempt from Social Security taxes.

Social Security isn’t just a lifeline for individual retirees and people with disabilities—it’s also a cornerstone of collective economic stability. The concept of an income cap undermines this principle, as it implies that some incomes are exempt from the shared responsibility of sustaining a social safety net. Removing the cap would reflect the truth that Social Security is a societal contract.

For a worker earning below the $168,600 threshold, 6.2% of wages are taxed for Social Security, matched by an equal contribution from their employer for a total of 12.4%. But higher earners, whose incomes may far exceed the cap, pay a disproportionately smaller share relative to their total earnings—making the tax itself regressive.

Some have argued that because benefits are tied to earnings during working years with a cap, benefits are progressively distributed in a mirror image of the regressive tax. By this logic, higher earners will contribute more to the Social Security program while receiving the same benefits as those who contributed less. This argument holds little water.

A regressive tax isn’t made progressive by revenue expenditures accruing disproportionately to individuals with lower income. For instance, few would give much weight to the argument that the income tax doesn’t need to be progressive because services funded by the tax are more often directed toward lower-income individuals than high earners. And sales taxes aren’t progressive just because state services may benefit lower-income individuals more than other groups.

The income cap for Social Security taxes creates an inequitable system where lower- and middle-income workers bear a greater relative share of the tax burden. Removing or significantly raising the cap would address this disparity and generate substantial revenue to shore up the program’s finances.

Public opinion broadly supports this approach. A majority of US residents—61%, according to recent polling by Gallup—prefer tax hikes to benefit cuts or retirement age adjustments.

Although raising the rate is another viable option, lifting the income cap would likely be more politically palatable, as 31% of Americans preferred curbing benefits to a direct tax hike. Raising the income cap would strike a policy middle-ground: increasing revenue to sustain benefits without resorting to deeply unpopular cuts or rate hikes.

But while raising the cap on taxable income is a good first step, it wouldn’t fully address Social Security’s forthcoming funding shortfall. Expanding the tax base to include investment income—such as capital gains, dividends, and interest—in Social Security taxation could ensure the program’s contributions better reflect the realities of income sources in 2024.

Social Security is funded chiefly through payroll taxes on wages, leaving a significant portion of upper-income wealth untaxed. Investment income plays a much larger role in wealth accumulation for high earners than it did at the program’s inception—Americans earned $3.7 trillion in investment income in the first quarter of 2024 alone.

A rough calculation suggests that if you apply the 12.4% combined rate for Social Security tax between employer and employee or self-employed individual, there is more than $400 billion in potential revenue per quarter. This would offset the 2023 annual deficit by about ten-fold in the first three months following enactment. Even a tax on investment income beyond a relatively high threshold, say $400,000, could go a long way toward ensuring Social Security solvency.

Opponents would say taxing investment income could deter economic growth and discourage investment, harming the economy and counteracting any benefit of a strengthened Social Security program. But making modest adjustments—such as adding a small percentage point to capital gains rates and earmarking that revenue for Social Security—would likely have negligible effects on overall investment behavior.

In addition to bolstering the program’s coffers, expanding Social Security taxes to include investment income would ensure that its funding reflects the realities of how income is earned. Today, a significant portion of wealth is derived from investments—especially among higher income earners. By extending Social Security taxes to encompass these income streams, policymakers would modernize the system to align with the ways wealth is generated some 89 years after the program’s introduction.

Time is running short to save Social Security. If Congress fails to act before the trust funds are depleted, continuing income to the program will only be able to cover 83% of scheduled payments—in other words, benefits will need to be cut by 17%.

This would be devastating for millions people who rely on their benefits as a lifeline. Further, it would break the social contract with recipients who have contributed to the program throughout their lives in exchange for long-term financial security.

By addressing the shortfall now, lawmakers can implement gradual changes and make time for policy tweaks. Waiting to act would only narrow the slate of options and increase the likelihood of needing more severe cuts and significant tax hikes in the future.

Andrew Leahey is a tax and technology attorney, principal at Hunter Creek Consulting, and adjunct professor at Drexel Kline School of Law. Follow him on Mastodon at @andrew@esq.social

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