Social Security is the federal government’s largest single program. About 56 million people will receive Social Security benefits this year, the Congressional Budget Office (CBO) estimates. About 69 percent are retired workers, their spouses, and children, and another 12 percent are survivors of deceased workers; all of those beneficiaries receive payments through Old-Age and Survivors Insurance (OASI). The other 19 percent are disabled workers or their spouses and children; they receive Disability Insurance (DI) benefits. CBO projects that in fiscal year 2011, Social Security’s outlays will total $733 billion, one-fifth of the federal budget; OASI payments will account for about 82 percent of those outlays, and DI payments, about 18 percent.
Social Security has two primary sources of tax revenues: payroll taxes and income taxes on benefits. This year, roughly 97 percent of tax revenues dedicated to Social Security will be collected from a payroll tax of 12.4 percent that is levied on earnings and split evenly between workers and their employers at 6.2 percent apiece (except for self-employed workers, who pay the entire 12.4 percent tax on earnings themselves). The payroll tax applies only to taxable earnings—earnings up to a maximum annual amount ($106,800 in 2011). Some Social Security benefits also are subject to taxation: This year, about 3 percent of Social Security’s tax revenues will come from the income taxes that higher-income beneficiaries pay on their Social Security benefits. Tax revenues credited to the program will total $687 billion in fiscal year 2011.
Revenues from taxes, along with intragovernmental interest payments, are credited to Social Security’s two trust funds—one for OASI and one for DI—and the program’s benefits and administrative costs are paid from those funds. Legally, the funds are separate, but they often are described collectively as the OASDI trust funds. In a given year, the sum of receipts to a fund along with the interest that is credited on previous balances, minus spending for benefits and administrative costs, constitutes that fund’s surplus or deficit.
In calendar year 2010, for the first time since the enactment of the Social Security Amendments of 1983, annual outlays for the program exceeded annual revenues excluding interest credited to the trust funds. CBO projects that the gap will continue: Over the next five years, outlays will be about 5 percent greater than such revenues. However, as more members of the baby-boom generation (that is, people born between 1946 and 1964) enter retirement, outlays will increase relative to the size of the economy, whereas tax revenues will remain at an almost constant share of the economy. As a result, the shortfall will begin to grow around 2017.
CBO projects that the DI trust fund will be exhausted in 2017 and that the OASI trust fund will be exhausted in 2040. Once a trust fund’s balance has fallen to zero and current revenues are insufficient to cover the benefits that are specified in law, the corresponding program will be unable to pay full benefits without changes in law. The DI trust fund came close to exhaustion in 1994, but that outcome was prevented by legislation that redirected revenues from the OASI trust fund to the DI trust fund. In part because of that experience, it is a common analytical convention to consider the DI and OASI trust funds as combined. CBO projects that, if legislation to shift resources from the OASI trust fund to the DI trust fund was enacted, the combined OASDI trust funds would be exhausted in 2038.
The amount of Social Security taxes paid by various groups of people differs, as do the benefits that different groups receive. For example, people with higher earnings pay more in Social Security payroll taxes than do lower-earning participants, and they also receive larger benefits (although not proportionately larger). Because of the progressive nature of Social Security’s benefit formula, replacement rates—annual benefits as a percentage of annual lifetime earnings—are lower, on average, for workers who have had higher earnings. As another example, the amount of taxes paid and benefits received will be greater for people in later birth cohorts because they typically will have higher earnings over a lifetime, even after an adjustment for inflation, CBO projects. However, initial replacement rates will be slightly lower, on average, for people in later birth groups because their full retirement age (the age at which they can receive unreduced retirement benefits) will be higher. The increase in that age is equivalent to a reduction in benefits at any age at which benefits are claimed.