A New Social Security Proposal Would Raise Taxes for Millions - Here's What to Know

A plan to preserve Social Security benefits for seniors might also raise taxes for millions of Americans. Senators Elizabeth Warren and Bernie Moreno's proposal to eliminate the Social Security payroll tax cap is just a proposal at this time, not an enacted law. Still, the proposal is attracting significant attention as conversation around Social Security's impending insolvency ramps up.

With millions of seniors facing a potential benefits reduction if a solution isn't identified soon, legislators are feeling the pressure to propose potential fixes.

The projected Social Security depletion date

The Social Security Trustees' 2026 report projected that the Social Security trust fund would be depleted by the fourth quarter of 2032. At that point, the Social Security program would only be able to pay 78% of the total scheduled benefits. That projection is one quarter earlier than the Trustees' projection from 2025.

If the Social Security trust fund becomes depleted, Social Security benefits would continue but might be automatically cut by 20 to 24%. According to Distinguished Professor Jon Dubin, director of the Economic Justice and Public Benefits Clinic, such a cut could be devastating for many recipients, since more than half of Social Security beneficiaries receive 50% or more of their total income from the benefits. Approximately one quarter of Social Security beneficiaries receive 90% or more of their income from the benefits.

How the insolvency issue could get worse

If Congress doesn't identify and implement a solution, the Social Security insolvency issue could get worse with time. Research from de Rugy and Fichtner reports that the program's annual shortfall could grow from $600 billion in 2033 to $700 billion by 2036.

Several factors are contributing to that shortfall, including fewer expected births, lower immigration, and slower workforce growth that all result in reduced tax revenue for the program. The size of the current worker pool is too small to fund the benefits needed by the large population of Baby Boomers.

How eliminating the Social Security payroll tax cap might work

Warren and Moreno have proposed lifting a cap on the amount of taxpayers' annual income that is subject to the Social Security payroll tax. That 12.4% payroll tax helps fund Social Security, and the taxes would help keep the program running if the trust fund is depleted. However, the current revenue generated from the payroll tax couldn't cover the full total scheduled benefits if the trust fund ran out.

Under current law, only the first $184,500 of an individual's annual income is taxed for Social Security. Any income beyond that amount goes untaxed.

How eliminating the payroll tax cap might affect taxpayers

The majority of American taxpayers would be unaffected by lifting the payroll tax cap, since most Americans don't make more than $184,500 per year. In fact, Americans who make less than that are paying Social Security taxes on their full income, while the highest earners in the country only pay taxes on a portion of their income.

These high earners would be affected by the change. According to an analysis by the Peterson Foundation, eliminating the tax might generate about $3.4 trillion in additional revenue for the Social Security program over the next decade. The Peterson Foundation reported that changing the tax cap might close about two-thirds of the Social Security funding gap. Additional solutions would need to be implemented to fully address Social Security's insolvency issue, but this change might have a significant impact on the program.

Additional potential solutions for Social Security

The proposal to eliminate the payroll tax cap is just one of many potential solutions that legislators have presented. Alternatively, legislators might raise the Social Security tax rate for everyone, increasing it from 12.4% to 16.6 or 16.7%.

Legislators also have the option of raising the Social Security retirement age. If legislators were to raise the age, the change would likely allow current retirees to follow the same rules, though younger workers would likely have to wait longer to claim their full Social Security benefit.

How a COLA adjustment might help

Some proposals suggest changing the formula used to calculate the Cost-of-Living-Adjustment (COLA), which helps ensure benefits keep up with inflation. Adjusting the formula might produce a smaller annual increase, and the change's effects could grow over time. Since each COLA builds on the previous year's COLA, even a slight reduction in the COLA could mean more substantial benefits reductions over a beneficiary's lifetime.

Bottom line

Warren and Moreno are reportedly "working on legislation," and no formal bill reflecting the proposed elimination of the tax cap has yet been introduced. The proposal is under discussion and is not definite. However, experts widely expect that any real Social Security fix may combine several of the proposed approaches, rather than relying on any one solution.

Since the future of Social Security is uncertain, it's worth revisiting your retirement plan and stress testing the plan using reduced benefits. Consider meeting with a financial advisor to check up on your retirement readiness and make sure that you're prepared to navigate retirement while receiving a smaller Social Security check.