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How is Social Security Funded?

Aparna Iyer Sep 29, 2018
Here is an explanation of the establishment and funding of the social security system. It also delves into the issue of inadequate social security funds.
Social Security System, that began in the year 1935, is a federal program that aims to provide retirement and disability income to workers and their dependents. At that time, the system was formally known as the Old Age and Survivors Disability Insurance (OASDI).
The Great Depression of 1929 and the crash in the stock market left many older Americans penniless. The idea of providing some kind of social support to the elderly resulted in the formation of the Committee on Economic Security in the year 1934 by President Franklin D. Roosevelt.
The Social Security Act, formerly known as the Economic Security Bill, was proposed in the year 1935, and approved and signed on to law in the month of August, the same year.

Dynamics of Social Security Funding

It was initially intended that this would be a fully funded system financed by payroll taxes. However, in the year 1939, the fully funded system was replaced by the pay-as-you-go system. Under the pay-as-you-go system, the money that is paid into the system is paid out immediately in the form of social security checks as retirement or disability income.
In other words, the payroll taxes that are paid by an employed individuals are used to pay retired workers. Thus, the current generation provides for the retiring generation.
The reason for adopting the pay-as-you-go system five years after the establishment of the system, was because the Great Depression had resulted in a number of elderly people requiring social security benefits. However, there was no money to pay for the benefits. At that time, this was the only way of ensuring a funded system.

Salaried Employees

People employed in the US are required to pay social security and Medicare taxes, regardless of the resident status of the employers or the employees. In some situations, work performed outside the US may also require a person to pay taxes on security. The deductions are made by the employer from the wages that are to be paid.

Self Employed

For self employed people, the self employment tax covers the social security and Medicare tax. Self employed tax has to be paid by resident aliens in accordance with the same rules applying to US citizens, provided the resident alien is not employed by an international organization, a foreign government, or a wholly-owned undertaking of a foreign government.
In this situation, the self-employed resident alien does not have to pay self-employment tax on income earned within or outside the US. Self employed non-resident aliens do not have to pay self employment tax.
The US has entered into Totalization Agreements with foreign countries in order to ensure that people who are salaried or self employed in the US and foreign countries for a part or all of their working career, do not get taxed twice for social security payments for the same work. Similarly, they are not entitled to receive dual coverage.

Funding Issues

In the year 2008, the Social Security's trustees projected a shortfall of more than $4 trillion. According to June 2018 report, if this current trend continues, the fund will be exhausted by 2034.
Both birth and death rate have declined over the years. Advanced medical facilities have resulted in people living longer. In the year 1935, a person was expected to live for 12.6 years after the age of 65. This has resulted in many people delaying claiming benefits so that they receive the benefits for a longer period of time.
Today, with baby boomers living well into their 80s, the need for social security benefits has risen considerably. However, the number of children per woman has reduced from 2.5 in the mid 1900s to 1.84. In other words, the support benefit ratio has declined considerably.
A number of measures have been proposed to fund the social security system. These include raising the cap on payroll taxes and raising the payroll tax ceiling (current social security wage base is $128,400), in order to ensure that it keeps pace with the growth in executive compensation.
In fact, many people who feel that the trust fund is meaningless since it is invested in government bonds, have also proposed the privatization of the system.