Thursday Video: Social Security (and Payroll Taxes) Turn 73 Years Old Today

August 14, 2008

Today is the 73rd birthday of the Social Security system in the United States. Signed into law in 1935, the first payroll taxes were collected in 1937 and the first payment made in 1940. Although initially the system was designed to pay out benefits from a reserve fund, it was changed in 1939 to “pay-as-you-go”—payroll taxes that are collected are immediately paid out to current retirees. Taxes are split, with half deducted from employee paychecks and the other half paid by the employer. Consequently, early retirees enjoyed a large windfall: the first recipient, Ida May Fuller of Vermont, for example, paid $22.54 in payroll taxes but collected $22,888.92 in benefits before her death at age 100.

Increased life expectancy and expanded benefits have led to increases in the Social Security payroll tax over time. Initially set at 2% (half each from employer and employee) in 1937-39, today it stands at 12.4% (6.2% each from employer and employee). In 2007, $481 billion in retirement benefits were paid to 40.9 million individuals.

The establishment of Social Security was not without controversy. Two 5-4 U.S. Supreme Court cases in 1937 challenged its constitutionality, arguing that the establishment of a retirement insurance program is not among the powers granted to the federal government. Anticipating this, officials structured the program in a way that divided the revenue and spending functions.

  • In Helvering v. Davis, 301 U.S. 619 (1937), the Court upheld the imposition of Social Security payroll taxes as constitutional, on the basis that they are general taxes not earmarked for any purpose.
  • In Steward Machine Co. v. Davis, 301 U.S. 548 (1937), the Court upheld the spending side of the program, holding that the federal government’s power to spend extends beyond enumerated powers. This settled (in the Court’s mind, at least) an argument going back to the Founding between James Madison (who argued that spending could only occur for enumerated powers) and Alexander Hamilton (whose view won out in 1937).

The future of the program remains in the headlines today. Payroll taxes were sharply increased in 1983, for the purpose of creating annual surpluses that could be accumulated for future payments. Since then, payroll taxes have raised $2.2 trillion more than program expenses, but this money was diverted to other government spending. The trustees estimate that the program will go into the red again around 2017, necessitating some increase in revenues or taxes, decreased benefits, or better returns.

The 12.4% payroll tax, also, is imposed on wages only up to $102,000 (adjusted annually for inflation). The cap was created as a way to maintaining some semblance of a retirement program, since an individual with wages over the cap would be unlikely to recoup in benefits what he or she paid in over time. Additionally, removing the cap at this point would force these individuals to pay more taxes while receiving no additional benefits, creating an equity issue. Given the experience since 1983, it’s unlikely that additional tax revenues would be used for Social Security, but probably would be diverted for other government spending. However, it remains a popular proposal for addressing some of the shortfall, with a version of it a centerpiece of Senator Obama’s plan.

See more on Social Security payroll taxes here.

Below, President Roosevelt signs Social Security into law, 73 years ago today:

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