Social Security – An Introduction

Preface “In the United States, a program that deals only with the poor will end up being a poor program.” – Wilbur J. Cohen

Social Security – An Introduction

The following is the first in a series of blog posts on Social Security. This first installment:

• • • Reviews the history of the Social Security program
    • Lists the different types of Social Security benefits

Future posts in this series will address:

• • • Claiming retirement benefits
    • Claiming survivor and family member benefits
    • How earned income is taxed to fund Social Security
    • How Social Security benefits are taxed
    • Estimating Social Security’s returns on investment

A Brief History of Social Security in the United States

Social Security was established with the Social Security Act of 1935. Its goal is to provide government insurance of income to the elderly and disabled and their dependents. It is administered by the Social Security Administration (SSA), an independent agency of the federal government created by the same 1935 act. It is the most significant and enduing of president Franklin Roosevelt’s New Deal programs.

The Social Security program was modeled on an earlier program designed to provide benefits for railroad workers under the Railroad Retirement Act of 1934. A year later, the federal government decided to create a similar system that would be mandatory on all types of employers.

When we speak of receiving “Social Security”, we are usually thinking of what is technically Old Age, Survivors, and Disability Insurance (OASDI). OASDI is funded by a special kind of income tax called Federal Insurance Contributions Act (FICA) tax.

The original Social Security Act established FICA tax so that Social Security would not be seen as government assistance for the indigent, but instead as an insurance program for all. Seen this way, FICA is not really a tax, but a mandatory insurance premium. This unusual feature of what would otherwise be just another government spending program continues to play a role in all discussion of possible changes to Social Security as it approaches the end of its first century of existence.

The Social Security Amendments of 1965 created Medicare, a government health insurance program run along similar lines to Social Security. Medicare is administered by the Department of Health and Human Services. These same 1965 amendments also expanded FICA taxes to include funding for Medicare.

By 1972, it was clear that FICA was not sufficient to fund Social Security needs. The Social Security Amendments of 1972 established a second program under SSA called Supplemental Security Income (SSI). Unlike OASDI, SSI is funded by U.S. Treasury general funds. These are the same general funds that fund other government programs. There is no pretense that SSI is a form of insurance.

A Brief Explanation of How FICA Works

At first, Social Security applied only to employees and not to the self-employed. The 1935 act established payroll withholding for the first time in history. This was done so FICA could be deducted from employees’ wages. The act also required, for the first time in history, that employers report and remit the withholding on a quarterly basis. Both the withholding and quarterly filing requirements for employers remain in place today and have expanded beyond their original purposes.

Within a decade, the federal government realized that with these new powers, they could collect and track withholding on regular income tax in addition to FICA. Income tax withholding and employers’ obligation to include it with quarterly payroll returns were codified in law with the Current Tax Payment Act of 1943.

Within another decade, mandatory participation in Social Security was extended to the self-employed with the Self-Employment Contributions Act of 1954. Since the self-employed have no wages to withhold, this act created a new kind of tax just for them. It was originally called SECA tax after the name of the act. It is now usually just called “self-employment tax”. This tax on the self-employed is figured in the same way as FICA and all FICA rate increases and other modifications over the years apply to the self-employed as well.

FICA was originally set at 2% but is now 15.3% of wages and self-employed income. Of this, 12.4% is due to Social Security and 2.9% to Medicare. The Affordable Care Act of 2010 (ACA or “Obamacare”) increased the Medicare portion to 3.8% on income above $200,000 ($250,000 for married filing jointly).

In a later post, we will discuss the nuts and bolts of FICA in more detail.

In general, FICA is a parallel income tax system collected by the IRS using the same processes as regular income tax (withholding, estimated tax payments, etc.). This is unusual in that the federal government has many, many different programs, probably more than anyone could ever count, that all require funding, and yet none besides OASDI and Medicare have their own special income tax that is collected and tracked separately.

We often hear in the news that Social Security will run out of funds by a certain year. This may well be true. Yet we never hear this said about the Air Force, the Small Business Administration, the Environmental Protection Agency, the Smithsonian, the National Endowment for the Arts, SNAP, NASA, etc., etc. Are all these other programs perfectly solvent? Hardly. There is just no pretense that they are to be self-funded, each through a special tax designed specifically for that program.

If you look at your W-2, you will see boxes for Social Security and Medicare deductions. You will not see a Navy deduction, an FBI deduction, a National Park Service deduction, etc. If any of those agencies need more money, the federal government will simply put itself further into debt to give it to them. Are we to believe that if Social Security needs more money, the government will just shrug and say: Sorry, dear senior citizens, you’re on your own…?

On the other hand, maybe it would be a good idea if every government program had to be funded through its own special line item income tax and could expect no additional funding. It would certainly make very transparent to taxpayers how much out of each paycheck was going to what program. At present, 15.3% is going to OASDI and Medicare, and apparently even that is not enough to keep them running for much longer.

Types of Social Security Benefits

There are two basic types of OASDI benefits:

• • • Disability (DI) –  A person of any income level found disabled by the SSA can claim benefits.
    • Retirement (OASI) – This is what we usually mean when we think of “Social Security”.

Benefits can also be claimed by:

• • • Survivors – This is the “S” in “OASI”. Surviving spouses and dependents of deceased OASI recipients can continue to claim the deceased recipient’s benefits.
    • Family members –family members of living OASI and DI recipients can claim benefits. Family member benefits are computed as a percentage of the primary recipient’s benefits.

The next post will explain who can claim retirement benefits and how they are figured.