How A Provision of Tax Reform Increases Chances of Lower COLAs

How A Provision of Tax Reform Increases Chances of Lower COLAs

By Mary Johnson, editor

The main source of funding for Social Security comes from the payroll taxes that workers pay into the program.  But there are two other sources of revenues: taxes that retirees pay on their Social Security benefits, and the “interest” earned by the “I.O.U.s” held by the Social Security Trust Fund.

The I.O.U.s in the Social Security Trust Fund are a special type of non-marketable bond issued by the U.S. Treasury when excess revenues are received.  The cash revenue that isn’t needed to pay benefits is “borrowed” and used for other government spending.  By law, the I.O.U.s held by the Trust Fund pay interest, and that forms an additional source of income — on paper, at least.

But while FICA taxes and the revenues paid by older taxpayers on Social Security benefits are real cash, the “interest” earned by the I.O.U.s is a “paper” accounting entry.  There’s no dedicated source of revenue for that money.  The money to repay the Social Security Trust Fund comes from general revenues, and Congress borrows more money by lifting the debt limit.

Federal revenues are now expected to be $1.5 trillion less over the next decade.  But, Uncle Sam still owes about $2.9 trillion in “interest” and the money needed to redeem the I.O.U.s held by the Social Security Trust Fund.  Paying the interest and redeeming the bonds will necessitate greater borrowing, new revenues — or, benefits would have to be cut (as some in Congress have recently announced plans to do).

The Social Security Cost-Of-Living Adjustment (COLA) is likely to be the first target for cuts.  Most deficit plans in recent years propose tying the annual inflation boost to a more slowly - growing consumer price index known as the chained CPI.  The new tax legislation, in fact, adopts the chained CPI to adjust tax brackets and the new expanded standard deduction.  That will mean the standard deduction will grow more slowly than before and that people will wind up in higher tax brackets, or a greater portion of their income will be subject to tax, more quickly than before.  For retirees, the chained CPI would mean lower COLAs, as well — if Congress extends the change to Social Security.

TSCL is strongly opposed to plans to “chain the COLA.”  Such a switch has been estimated to reduce Social Security benefits by about 7% over a 30-year retirement.  An average benefit of $1,300 in 2017 would be about $175 per month less at the end of the period than it would be using the current CPI.  An index that causes higher taxes, and lower retirement benefits, make the chained CPI a bad deal for older Americans.