In this article, we explore the complexities surrounding the financial health of Social Security, which is expected to face significant benefit cuts by 2032. As it stands, Social Security relies primarily on payroll taxes; however, a smaller percentage of U.S. income is currently generated from wages.
This discussion omits the impact of the Trump-era tax reforms that allowed business owners to take larger portions of their compensation through business profits rather than traditional salaries.
By Pia Malaney, Associate Research Director at the Institute for New Economic Thinking. Originally published at the Institute for New Economic Thinking website
The ongoing discussions about Social Security “running out of money” often reflect political tensions rather than the program’s financial reality. Before diving into the financial intricacies, it’s crucial to acknowledge the program’s monumental successes. Social Security has revolutionized old-age security in the U.S. It has transformed a period that was often characterized by dependence into one sustained by a robust national insurance system, all within the span of a single working life. Data from the Center on Budget and Policy Priorities illustrates this achievement: without Social Security, the poverty rate for Americans aged 65 and older would exceed 40 percent in nearly a third of states, while with it, poverty rates drop below 10 percent in almost two-thirds of states.
Such success heightens the stakes in current debates regarding Social Security’s future. To understand the financial concerns, we should clarify what is meant by the trust fund projected to become depleted. Social Security operates primarily on a pay-as-you-go basis: current payroll taxes fund today’s benefits, while the “trust fund” merely holds surplus funds from more prosperous years, invested in special Treasury bonds. This fund serves both financial and political purposes, as articulated by Franklin D. Roosevelt in 1941. His intention was to ensure that Americans viewed their contributions as a right to their benefits, making it politically challenging for future policymakers to dismantle the program.
The 2026 Trustees Report projects that the combined trust funds[1] will be “depleted” by the third quarter of 2034, though incoming revenues would still cover 83 percent of scheduled benefits. The Old-Age and Survivors Insurance fund is likely to be exhausted even sooner, by late 2032, allowing for 78 percent of benefits to remain payable. It’s important to clarify that this situation does not equate to bankruptcy: payroll taxes will continue to flow, meaning some benefits will still be distributed. However, a sudden cut of 20 percent in retirement income would significantly impact millions of households reliant on these payments, as private retirement savings are often concentrated among wealthier individuals.
Where the Money Went
The widespread perception of a shortfall is primarily demographic in nature, which is not incorrect but offers an incomplete picture. The baby boomer generation has retired, lifespans have increased, and fertility rates have dropped below replacement levels. As a result, fewer workers are supporting a growing number of beneficiaries. The 2026 Trustees Report attributes recent declines in funding to lower projected fertility and net immigration rates.
However, focusing solely on demographic factors overlooks critical aspects of the program’s foundation. Social Security was originally designed around an economy where most people earned wages, which would steadily rise over time, financing the benefits for previous generations. It also assumed a largely self-contained economy, where the wealthiest individuals couldn’t easily relocate their assets overseas.
When President Roosevelt signed the Social Security Act into law during the 1930s, it was both timely and hopeful; it aimed to reignite the long-term upward trend in wages that had been interrupted by the Great Depression. For about forty years, Social Security fulfilled this promise, as each generation contributed to a communal financial pool that it would eventually draw on. However, this design rested on the assumption that wage growth would continue in step with overall economic growth—an expectation that has waned over time.
The Social Security Act has never stood still; it has been amended several times to adapt to shifts in economic conditions, demographics, and political landscapes. Initially, it excluded nearly half the workforce, including farmers, domestic workers, and many self-employed individuals. These exclusions predominantly affected Black and female workers, as many were employed in those sectors. Coverage was gradually expanded starting in 1950, incorporating most previously excluded groups.
Today, Social Security is funded through payroll taxes applicable to covered income—capped at $184,500 in 2026. Employers and employees each contribute 6.2 percent below this threshold, while self-employed individuals pay 12.4 percent. While the cap is designed to rise with average wages, increasing income inequality means more earnings escape the taxable maximum, reducing the overall funding available. In 1983, around 90 percent of covered earnings fell within the taxable maximum; by 2020, that figure had decreased to approximately 83 percent, resulting in a significant financial shortfall.
This shift is exacerbated by the fact that Social Security taxes primarily labor income, neglecting capital gains, dividends, and business income—sources increasingly prevalent among wealthy individuals. Evidence suggests that technological advancements and automation have steadily eroded labor’s share of total production.[2] In 2024, employee compensation accounted for about 51.9 percent of gross domestic income, a decline from historical averages in the mid-to-high 50s during the postwar era.
Leading economists have attributed the declining share of wages to various factors, including the resurgence of a wealthy capitalist class under neoliberalism and the focus on maximizing shareholder value in corporate America. While some executive compensation appears in wage statistics, it understates the broader losses sustained by workers. Studies show that since around 1980, approximately eight percentage points of primary income have shifted from labor to capital, primarily due to wage repression. Regardless of the specific causes, they collectively indicate a growing proportion of national income that is no longer tied to wages, with the majority flowing to the already affluent.
This change is not just about income distribution; it also reflects how globalization has shifted labor dynamics. Work is increasingly moved offshore, leaving the domestic wage system unable to adjust adequately. This evolution further distances the economy from the initial assumptions of Social Security’s design.
While this analysis does not directly translate to Social Security funding deficits, it highlights the challenges a retirement system reliant solely on payroll taxes faces in an economy characterized by a growing share of gains accruing outside of wages.
The Menu of Fixes
One proposal to address the deficit involves restoring the taxable maximum so that approximately 90 percent of covered earnings are subject to taxes, phased in between 2026 and 2035. This adjustment could close about 22 percent of the 75-year actuarial deficit if the newly taxed earnings also earned benefit credits. More aggressive alternatives suggest applying the 12.4 percent payroll tax on earnings above $250,000 and eventually on all earnings, thereby addressing a larger portion of the funding gap, contingent on whether these additional taxes yield more benefits.
The benefits aspect of this discussion is crucial, both financially and politically. Currently, the design ties both tax and benefits to covered earnings, creating a structure where contributions determine benefits. Experts such as Kathleen Romig have proposed disassociating these elements, which could enhance the program’s redistributive capacity and improve its financial stability. However, doing so would challenge the earned-benefit narrative that has politically sustained the program for nearly ninety years. Maintaining this connection, on the other hand, may limit opportunities for solvency improvements. Striking a balance between these two considerations has been a persistent challenge for Social Security.
The complexity of the cap issue is further highlighted when considering distributional impacts. Because payroll taxes apply only to wages and self-employed income, higher taxes or the elimination of the cap would predominantly affect professionals like doctors and lawyers while leaving vast fortunes stemming from capital largely untaxed. This creates a perceived unfairness, which poses a political risk for reform efforts.
Congress could also choose to raise the combined payroll tax rate. Estimates suggest that increasing the rate from 12.4 percent to 16.65 percent starting in 2026 would fully eliminate the long-term shortfall. However, this approach burdens both low-wage workers and high-income earners, making it less politically palatable. Historically, most reform proposals center on cap adjustments instead. Furthermore, the payroll tax is split between employers and employees but often, employers pass their portion onto workers through reduced wages, meaning labor bears the majority of the burden, especially in a time of stagnant wages.
The option of adjusting the retirement age is another possible remedy; proponents argue that longer life expectancies justify longer working years. However, this perspective fails to account for disparities in life expectancy across income levels. Research indicates that wealthier individuals live considerably longer than those at the lower end of the income spectrum. Raising the retirement age disproportionately affects workers in physically demanding jobs, who may not be able to work well into their late sixties, unlike others with more flexible careers.
Every solution involves specific groups absorbing some of the associated costs: ordinary workers through tax increases, vulnerable retirees through later retirement ages, or high earners via uncapped taxes. The distribution of these burdens complicates the process of achieving meaningful reform, as it necessitates that both political parties share the associated political risks. The successful 1983 amendments emerged from a compromise that included both tax increases and benefit cuts, ensuring that no single party bore the blame. Today, the landscape appears more fractured, as Democrats favor preserving benefits funded through taxing high earners, while Republicans seek to avoid new taxes and are resistant to alterations in benefits.
Beyond the Paycheck
Addressing the cap can alleviate some immediate issues, yet it does not tackle a pivotal concern at the heart of this debate: the distribution of wealth over time. If a significant proportion of income at the top now comes from capital rather than wages, why should funding for retirement programs remain so closely linked to wages? Medicare’s tax system provides a contrasting example, as it taxes all wages without a cap. While this doesn’t resolve Medicare’s financial difficulties, it demonstrates that Congress is willing to reconsider traditional limitations. Extending this logic to Social Security could take various forms—such as taxing investment income directly, treating stock options more consistently as labor income, or introducing a new revenue source based on capital. However, each approach could encounter its own set of design and political challenges due to the volatility of capital income and its defense by the affluent.
Technology, especially artificial intelligence, compels us to reevaluate these financial frameworks. Acemoglu and Restrepo’s research indicates that automation can reduce labor’s share of total output without outright job elimination; it merely must occur faster than job creation. The optimistic outlook is that AI could enhance productivity and create new job categories, similar to the positive impacts of electricity or automobiles. Yet, a more concerning possibility is that it could undermine labor’s bargaining power consistently, directing economic gains towards capital owners rather than wage earners.
In essence, America is capable of financing support for its aging population; implying otherwise obscures the true question at hand: whether the nation can continue to anchor retirement security on wages in an economy where capital gains are increasingly prevalent. Social Security’s next challenge goes beyond merely demographic factors; it must adapt to an economy where income sources are shifting away from wages. The principles on which the program was founded are being challenged. To secure the future of Social Security, Washington must focus on redesigning its financing based on the contemporary economic landscape rather than relying on outdated methods established in 1935.
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[1] Social Security consists of two legally distinct trust funds: Old-Age and Survivors Insurance (OASI), which provides benefits for retirees and families of deceased workers, and Disability Insurance (DI), which supports those unable to work. Each fund receives a portion of the 12.4 percent payroll tax and maintains its own balance, with movements between the two necessitating Congressional action. The so-called “combined” OASDI fund is primarily a matter of accounting convenience.
[2] For further examples, see Autor, Levy, and Murnane, 2003 or Acemoglu and Restrepo, 2018.
