The History of Major Changes to the Social Security System

By Teresa T. King and H. Wayne Cecil

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Earliest Developments

In 1934, President Franklin D. Roosevelt created the Committee on Economic Security (CES). The CES was assigned the task of studying the need for an economic security system to provide income for the elderly and disabled. Care for those unable to work was traditionally provided by family members or, in limited cases, by the government. Roosevelt recognized the need for a national system. In January 1935, the CES issued a report to President Roosevelt outlining a plan for a national program of economic security. This plan ultimately became the Social Security Act (SSA), which was passed by Congress on August 14, 1935.

The SSA created a social insurance program covering a variety of individuals. The law provided a monthly benefit to individuals age 65 and older and no longer working. The monthly benefit was paid to the primary worker when he retired; the amount received was based on the individual’s payroll tax contributions. The SSA also provided unemployment insurance, aid to dependent children, and grants to states for medical care. The Social Security Board was established and charged with implementing a system to enroll employees, report earnings, and collect payroll tax contributions. Under the initial SSA, monthly benefits were to begin in 1942; from 1937 until 1942, Social Security would pay out a single lump sum to anyone retiring. This “payback” sum was given to those paying into Social Security but not having sufficient contributions to vest in monthly benefits.

Changes to the 1935 Act

There have been several important amendments to the original 1935 Social Security Act. In 1939, Social Security was modified to add benefits to the spouse or minor children of a retired worker. It also added a survivor’s benefit, paid to the family in the event of the premature death of a covered worker. Thus, with the 1939 amendment, the idea of economic security became a family-based program rather than an individual-based one, and one that provided benefits for retirement, disability, premature death, and medical costs after retirement. The payment of monthly benefits was accelerated to begin in 1940 rather than 1942. Interestingly, the first monthly retirement check was issued to an individual who had paid a total of $22.54 into the system and received $22,000 in benefits over her lifetime!

The next significant change to the SSA occurred in 1950, when the first cost of living adjustment (COLA) was added the program. This was a one-time increase in benefits of 7.7%; the next COLA occurred in 1952, a 12.5% increase. In 1954, a stipulation was added that would freeze a worker’s record during the years he was disabled and unable to work. This amendment avoided a worker’s receiving reduced or no benefits in the event of a disability.

In 1961, the retirement age for men was reduced to 62, with a reduced monthly benefit for those choosing to retire early. Several major changes to Social Security occurred with the 1972 amendment: automatic COLAs were instituted, a minimum monthly benefit was established, monthly benefits were significantly increased to those individuals waiting until age 65 to retire, and a system for automatic increases in the amount of earnings subject to Social Security taxation was developed.

Social Security Today

The first recognition of the fragility of the Social Security program occurred in 1975. A report developed by the Treasury Department indicated that Social Security payroll taxes collected would be insufficient to meet Social Security payments by 1979. In response, Congress increased the tax rate, reduced benefits, and made the automatic adjustment to the amount of earnings subject to Social Security independent of the COLA. These steps averted a potential Social Security failure.

In 1983, another potential Social Security crisis was avoided. President Ronald Reagan formed the Greenspan Commission to study the financial state of Social Security. The commission issued a detailed report calling for numerous, sweeping changes to be implemented in order to strengthen Social Security. A bill passed by Congress based upon the recommendations of the Greenspan Commission taxed some Social Security benefits, included federal employees in the definition of employees for Social Security payroll tax purposes, and scheduled increases in the retirement age in the next century.

In his February 2005 State of the Union Address, President George W. Bush indicated that strengthening Social Security was one of the priorities for his second term in office. He stated that unless significant changes were implemented, Social Security is headed toward bankruptcy. The March 23, 2005, report of the Trustees of the Social Security Fund painted a grim picture. The report indicated that Social Security contributions would peak in 2008 and decline thereafter. By 2018, the report stated, the government will begin paying out more than it collects in payroll taxes, with the deficiency growing each year: $200 billion deficiency by the year 2027, $300 billion by the year 2033, and then the system would be bankrupt.

When Social Security was implemented in 1935, the amount of earnings subject to tax was $3,000. The tax rate was 1%. As the Exhibit indicates, in 1966 the Medicare tax rate was split from the Old Age, Survivor, and Disability (OASDI) rate. By 2005 the OASDI rate is 6.2% for both employer and employee on earnings up to $90,000; the Medicare rate is 1.45% with no cap on earnings. There have been 20 increases in the OASDI rate since the inception of the program. Historically, the majority of additional funds needed for Social Security were obtained by increasing the rate and the earnings subject to taxation. When Social Security was implemented, there were 16 workers for every Social Security recipient; today there are 3.3 workers for every recipient, and it is estimated that by 2030 there will be only two workers for every recipient. A “pay as you go” approach becomes less feasible when there are fewer workers supporting each benefit recipient. Another factor contributing to the concern about the state of the Social Security system is the fact that in 1935 fewer people lived long enough to collect benefits; the average life expectancy was 67 years. Today the average life expectancy is 77 years, and there are more than 48 million recipients. A more detailed history of Social Security is available at www.ssa.gov/history.

A majority of people anticipate that Social Security will form a significant part of their retirement income. The AICPA (“Understanding Social Security Reform: The Issues and Alternatives,” March 2005) identified that Social Security currently comprises more than half the income for more than 60% of the program’s beneficiaries; furthermore, for 30% of its beneficiaries, Social Security represents more than 90% of their total income. Thus, any proposed change that might impact benefits received or taxation of benefits will have a significant impact on retirement planning.

Social Security: Tax or Insurance?

When Congress implemented Social Security in the 1930s, was Social Security intended as a social welfare program that would redistribute wealth to retirees? Or was it intended to be an insurance program that workers paid into during their working years and received benefits from during their retirement years or if they became disabled? An analysis of these questions might shed light on the direction of Social Security in the future.

Originally, President Roosevelt called for “social insurance.” He envisioned a plan through which workers would contribute and provide for their own future economic security. He specifically disdained the idea of reliance upon welfare. The original SSA embraced the idea of Social Security being an insurance program under which a group of individuals were insured against identifiable risks: disability and old age. Workers paid for their own insurance. The concept pools the risk of disability or loss of income due to old age among a large number of individuals and pays out to those who live long enough to reap the benefit. If Social Security is thought of as an insurance program, then only those who had paid into the system should receive benefits. In addition, the benefit should be payable only to the insured individual and not to the insured’s spouse or family. If the benefit can be paid to a spouse or family, then an individual without a spouse or family should be able to identify a “beneficiary.” Finally, there should also be a direct correlation between the amount paid in and the benefit received, without a benefit cap or the taxation of benefits for wealthier recipients.

On the other hand, should Social Security be considered a tax, with benefits paid based upon social entitlement? If so, then the benefit received would not correlate to the amount paid. Most kinds of taxes (income, property, sales) are paid without the expectation on the part of the payor of receiving commiserate benefits. Currently, Social Security benefits are calculated based upon the income earned by an individual, up to a capped benefit amount (the formula uses a smaller percentage as income increases). Under the current system, the AICPA has identified a redistribution of income from 1) single participants to married participants, 2) high-income participants to low-income participants, and 3) two-earner couples to one-earner couples. These net redistributions must be taken into consideration in evaluating the Social Security system. Any proposed changes must weigh whether Social Security is an “insurance program” or a “tax” for the redistribution of income. One current proposal, the use of a “means test” to determine who should receive Social Security benefits, would solidify the program as a tax intended to redistribute income.

Insight into the System’s Evolution

Social Security has been touted as one of the great moral successes of the 20th century, providing economic security to citizens in their old age and in the face of sickness, disability, or the death of a provider. Social Security has faced a number of challenges throughout its 70-year lifetime. A study of the history of Social Security provides insight into how the system has evolved and identifies measures which have been taken in the past to financially stabilize the program. The accounting profession can contribute to the discussion of Social Security reform by providing unbiased and independent analysis of proposed alternatives. CPAs can help the public understand alternatives in light of the historical context of Social Security and can explain the economic and tax implication of any change. In addition, CPAs will need to assist those planning for retirement to consider how any change might impact their retirement income.