Social Security Reform: Options to Raise Revenues
Last Updated March 7, 2025
Social Security is the primary source of government-funded retirement support in the United States. Since its establishment in 1935, Social Security has grown to become the largest program in the federal budget; outlays in 2024 represented more than one-fifth of total federal spending. However, the Social Security Trustees project that, with the retirement of baby boomers and lengthening of life expectancies, the Old-Age and Survivors Insurance (OASI) Trust Fund will spend more every year in payments to beneficiaries than it collects in revenues. As a result, the trust fund will be depleted by 2033. At that time, an estimated 70 million recipients would see a 21 percent reduction in their benefits.
Many options exist to shore up the solvency of OASI, including increasing revenues dedicated to the program, raising the full retirement age, and decreasing the program’s benefits. A balanced approach that includes components from each option in combination would likely provide the fairest, most lasting, and least painful adjustment for the future. Here we examine proposed modifications to Social Security that would increase income assigned to the program.
How Is Social Security Funded?
Social Security is primarily funded by revenues raised through a dedicated payroll tax. At the time of its inception in 1937, that payroll tax rate was set at 2 percent, with 1 percent paid by employers and 1 percent by employees. The rate has since been increased 20 times, with the most recent increase taking place in 1990, when the combined rate was set at 12.4 percent (still divided evenly between employers and employees). However, the rate was temporarily lowered in 2011 and 2012 to help alleviate the hardship resulting from the Great Recession.
The 12.4 percent payroll tax rate is applied to all wages up to a designated income limit, commonly referred to as the Social Security tax cap, which is adjusted annually based on growth in the national average wage index. For 2025, that cap was set at $176,100, an increase of $7,500 over the 2024 level.
Inflows from the Social Security payroll tax represent the vast majority of the program’s annual income. According to the Social Security Administration, the payroll tax raised $1.1 trillion in 2023, representing 90 percent of the trust fund’s total income that year. The remaining 10 percent of OASI income in 2023 came from interest earned on trust fund reserves held in non-marketable U.S. Treasury securities (5.4 percent) and from a tax on the Social Security benefits paid by high-income beneficiaries (4.3 percent).
What Policy Options Exist to Increase Revenues Dedicated to Social Security?
This section examines six policy options presented by the Social Security Administration that would increase funds dedicated to the program.
Raise or Eliminate the Social Security Tax Cap
In 2025, workers will only pay Social Security tax on the first $176,100 of wage income. According to the Social Security Trustees, eliminating the Social Security tax cap while providing benefit credit for those earnings would raise an additional $3.2 trillion over 10 years — or close 53 percent of the 75-year funding gap. The Trustees also analyzed the revenue-raising effects of a different proposal. In that option, the tax cap would still partially exist, but wage income over $250,000 would also become subject to the 12.4 percent payroll tax and part of benefit calculation. As the tax cap increases with inflation, the gap between the “indexed cap” and $250,000 would narrow until all wage income was subject to the tax. According to the Trustees’ projection, that option would raise $2.7 trillion over 10 years.
Proponents of increasing or eliminating the Social Security tax cap believe that doing so would help make the overall payroll tax system less regressive by increasing the total tax liability of high-income earners. What is more, advocates argue that entirely eliminating the taxable maximum would help combat the trend of increasing income inequality in the United States, particularly given that higher-income individuals tend to live longer than their low- and medium-income counterparts and receive larger Social Security benefit payments for a longer time.
Opponents of increasing or eliminating the Social Security tax cap argue that it places an unfair burden on high-income earners. Low- and medium-income earners, who tend to pay a greater proportion of their income in payroll taxes, are also the primary beneficiaries of government transfer payments (such as unemployment insurance, Temporary Assistance for Needy Families, and the Children’s Health Insurance Program). Those transfers are not subject to payroll taxes. Another argument against increasing or eliminating the Social Security tax cap is the fear that doing so would stymie job creation and economic growth, leading to increasingly stagnant wages and an ultimate decline in the national savings rate. Lastly, some opponents fear that increasing or eliminating the payroll tax cap would disincentivize certain people from continuing to work because larger tax burden would be greater than the expected lifetime Social Security benefits for some individuals.
Increase the Social Security Payroll Tax Rate
Another option to help shore up Social Security’s long-term solvency would be to increase the payroll tax rate, similar to legislation enacted as a product of the 1983 Greenspan Commission’s recommendations on Social Security reform. According to an analysis from the Social Security Trustees, increasing the payroll tax by 0.1 percentage point from 2026 through 2035 until it reached 13.4 percent would raise $601 billion in new revenues for Social Security over the next 10 years. The increase would shrink the program’s 75-year shortfall gap by 26 percent.
Proponents of increasing the payroll tax rate believe that it would be a relatively simple revision to administer because it would not involve major changes to the tax system. They also contend that an increase of 0.5 or 1.0 percentage points to an employee’s overall payroll tax obligation is not likely to result in significant additional financial strain for a majority of Americans. Proponents also highlight that the increased tax obligation would be borne equally by employers and employees, unlike traditional tax increases which are borne entirely by employees.
Opponents of increasing the payroll tax rate argue that doing so would exacerbate the regressive nature of the tax and unfairly affect low-income workers, since low- and moderate-income individuals typically pay a higher proportion of their overall income in payroll taxes than do high-income earners. According to a report from the Congressional Budget Office (CBO), the bottom 90 percent of individuals paid a lower rate for the individual income tax than the payroll tax. Therefore, an increase to the payroll tax rate would have an outsized effect on the total tax obligation of most Americans who pay a majority of their total tax liability in payroll taxes.
In addition to concerns that increasing the payroll tax rate would exacerbate the regressive nature of the tax, some critics fear that such a policy would have negative effects on overall productivity. An analysis from CBO notes that an increase in the payroll tax rate could encourage workers to work fewer hours because a higher statutory rate would make other uses of their time relatively more attractive. Furthermore, critics argue that simply increasing the payroll tax rate without also increasing Social Security benefits would not be fair to those workers for whom the share of total taxes represented by payroll taxes increased, since the tax burden for those individuals would go up but their retirement earnings from Social Security would remain unchanged.
Options to Broaden the Social Security Tax Base
The Social Security Administration also examined the financial effects of policy options that would broaden the Social Security tax base. Those include:
- Applying a 12.4 percent tax on investment income: To finance some of the new programs included in the Affordable Care Act, lawmakers also enacted a new net investment income tax (NIIT). The NIIT is a 3.8 percent tax on investment income — including income from interest, dividends, annuities, royalties, certain rents, and certain other passive business income — for taxpayers with modified adjusted gross income in excess of $200,000 for single filers or $250,000 for joint filers. That 3.8 percent is equal to Medicare taxes that are applied to high-income taxpayers (the basic 2.9 percent plus the 0.9 percent Additional Medicare tax on individuals’ wages exceeding $200,000). The option would create a new tax similar to the NIIT, taxing investment income above the same thresholds. However, the tax would be set to the same rate as the Social Security payroll tax, and the additional revenues would flow to the Social Security trust funds. Creating the new tax would increase Social Security revenues by $1.3 trillion over 10 years or close 38 percent of the 75-year funding gap.
- Subject employer-sponsored health insurance to payroll tax: Premiums for employer-sponsored health insurance are currently excluded from federal income and payroll taxes. According to CBO, that exclusion is the largest payroll tax expenditure. Starting in 2028, the option would limit the exclusion for employer-sponsored health insurance to only the bottom 75 percent of the premium distribution. The top 25 percent of premiums would then be subject to the payroll tax. The exclusion would be reduced by 10 percent each year until eliminated in 2038. The Social Security Trustees projected that subjecting such premiums to the payroll tax would increase revenues by $550 billion over the next 10 years or close 31 percent of the funding gap.
- Subject cafeteria plans to payroll tax: Cafeteria plans allow employees to elect to participate in certain benefits that are paid for on a pre-tax basis. Common cafeteria plans include health plans like Flexible Spending Accounts (FSAs) and Health Savings Accounts (HSAs) as well as dependent care assistance plans. Cafeteria plans reduce an employee’s taxable income, thereby reducing payroll tax revenues. Subjecting cafeteria plans to the payroll tax could increase revenues by $525 billion over 10 years or close 10 percent of the funding gap.
- Cover all newly-hired government employees: Another revenue-raising policy option is to expand Social Security coverage to include all newly hired state and local government employees. Under current law, state and local governments can opt out of enrolling their employees in Social Security if they instead provide a separate retirement plan. Today, roughly one-quarter of all state and local government employees are not covered by Social Security, and thus are not subject to the Social Security payroll tax. According to the Social Security Administration, expanding Social Security coverage to include all newly hired state and local government employees would raise $189 billion in new revenues for the program over a 10-year period or close 4 percent of the funding gap.
Conclusion
Social Security is in dire need of reforms to address the major financial challenges it faces, which will affect tens of millions of Americans in the coming years. When it comes to increasing revenues dedicated to the program, there are a number of viable options for policymakers to consider that would narrow Social Security’s solvency gap and put the program on sounder fiscal footing. As lawmakers consider various reforms, it is critical that they work to strike the right balance between the adequacy of benefits for recipients, fairness, and the financial and fiscal implications for the federal government.
Further Reading
Why Do Budget Baselines Matter?
Applying the current-policy baseline would not only be fiscally irresponsible in terms of this year’s tax debate, but it would set a dangerous precedent for the future.
What Is the Farm Bill, and Why Does It Matter for the Federal Budget?
The Farm Bill provides an opportunity for policymakers to comprehensively address agricultural, food, conservation, and other issues.
Should the U.S. Change the Corporate Tax Rate in 2025?
Here’s why lawmakers lowered the corporate tax rate in 2017, how the lower rate impacted the U.S., and how the rate might be reformed in 2025.