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A recent study reveals how rising income inequality is jeopardizing Social Security’s finances.

A recent study reveals how rising income inequality is jeopardizing Social Security’s finances.

It is by now common to hear Social Security advocates demand that we “scrap the cap” on earnings subject to the Social Security payroll tax.

This is an important appeal. Few Americans realize that millionaires only contribute to Social Security on the first $110,100 they earn. If they did, perhaps they’d be even more adamantly opposed to the benefit cuts many in Washington are proposing.

But even fewer people realize that the “cap,” or taxable maximum, as it is called more officially, at one time covered a far larger share of earnings, existing in harmony with fully-funded Social Security benefits. In fact, the cap was baked into Social Security from its inception.

The Evolution of Social Security’s Taxable Maximum, a recent study by Kevin Whitman and Dave Shoffner from the Social Security Administration’s Office of Retirement Policy, shows how rising income inequality has greatly increased the amount of earnings above the tax-max, depriving Social Security of much-needed revenue and shifting a larger share of its financing onto middle- and low-income workers.

The truth is that Social Security’s taxable maximum was born of smart policymaking. The tax max helped Social Security meet “the goal as a social insurance program of focusing on low- and middle-income workers who were more likely to be economically vulnerable in retirement.” FDR initially proposed to exempt high-income earners. The House Ways and Means Committee replaced the exemption with a taxable maximum on earnings, reasoning that virtually all workers need at least some basic level of protection against lost wages in old age.  Moreover, fluctuations in individuals’ income above and below the exemption level would cause the number of workers covered by the program to fluctuate.

The tax max started at $3,000 in 1937, the first year covered workers began contributing to Social Security. Congress increased the dollar amount on an ad hoc basis for several decades thereafter, in much the way it raised benefit levels and expanded coverage to new sectors of employment. In 1972, Congress finally indexed the tax max to changes in the average wage index. Because the automatic indexing put in place in 1972 did not work as intended as a result of the unanticipated stagflation of that decade, Congress modified it and specified as a goal that 90 percent of all wages nationwide be insured against loss by Social Security. These measures were largely successful, bringing the portion of earnings covered by Social Security to 90 percent of earnings in 1982 and 1983.

Since that time, the tax max has continued to go up with average wage increases, but rising income inequality has caused the percentage of the country’s total earnings covered by the tax max to steadily decline. “Wages above the tax max generally have grown more quickly than wages overall,” Whitman and Shoffner write. The percentage of the country’s earnings covered by the tax max has dropped from 90 percent in 1983 to 84.2 percent in 2010, and is slated to drop to 83 percent in the coming years.  This seemingly small slippage translates to billions of lost revenue for Social Security every year.

While the percentage of the country’s earnings above the cap has increased, the percentage of workers with earnings above the cap has remained static—a telling reflection of the extent to which wealth is now concentrated in the hands of the few. In 1983, 6 percent of workers accounted for the 10 percent of the country’s earnings above the tax max. In 2010, the same percentage of the workforce accounted for a much greater portion of earnings above the tax max—nearly 16 percent.

Even if Social Security were not facing a modest shortfall beginning in 2036, the drop in the percentage of covered earnings below 90 percent deserves correction. Several Washington commissions have proposed raising the tax max to gradually cover 90 percent of earnings once again. This would in fact close one-third of Social Security’s projected long-term shortfall.

But increasing the tax max is often pitched as a major concession to the Left, rather than a correction for the consequences of rising inequality. As such, the price of its passage becomes wholesale passage of major benefit cuts that please the Right, but dismay the public.

If politicians in Washington want to be honest with the American people, they would raise the tax max as a matter of course – and should have decades ago—not use it as a pawn in negotiations to cut the program. Better still, they could enact policies to reduce income inequality so that more of Social Security’s earnings remain taxable.

If politicians want to completely restore Social Security to long-range balance, they should consider scrapping the cap entirely. That is what, poll after poll reports, the American people overwhelmingly favor.

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Comment Preferences

  •  DMarans - good diary (2+ / 0-)
    Recommended by:
    Roger Fox, kurt

    I think there are several options for SocSec, one is to gradually raise the cap and a second is to eliminate the cap. I think there is broad bipartisan support for gradually raising the cap. The big issue with eliminating the cap is how do you treat the additional contributions from high income earners? Do you just follow the current algorithm and allow benefits to rise, but like now giving less retirement credit for each new dollar of contribution? Or do you fundamentally change SocSec from its foundational principles by capping the benefits of the high contribution participants?

    "let's talk about that"

    by VClib on Tue Nov 15, 2011 at 09:48:32 AM PST

    •  Yeah OK, but my 1st choice is job creation (1+ / 0-)
      Recommended by:
      kurt

      Widespread job creation and real wage growth. Lacking that there are options as you state.

      At this time I do not accept contunued GDP growth of 2.6% that brings us to SS going broke in 2036. To me it is unfathomable to think that the current recessionary level of GDP growth is a reality that should be accepted thru 2036. ANd if that does happen, there will be other infrastructural problems rising their ugly heads in the 2030's that may eclipse SS solvency.

      The current economic path is not sustainable, SS will only be one of many problems in 2036.

      BTW, tnR

      FDR 9-23-33, "If we cannot do this one way, we will do it another way. But do it we will.

      by Roger Fox on Tue Nov 15, 2011 at 11:07:33 AM PST

      [ Parent ]

      •  more equality matters independent of growth rate (1+ / 0-)
        Recommended by:
        kurt

        1. The Trustees assumption of slower future GDP growth has everything to do with slower growth in the labor force which is mostly a demographic inevitability as the population ages. It is not a measure of decaying economic capacity. When you explain why you think labor force growth will not slow as much as the Trustees assume then you might actually have the beginnings of an argument.

        One answer could be that you think immigrants will make up the difference. Or older workers will not leave the labor  force so quickly. Etc...

        2. Even with much higher level of employment and wage growth increasing inequality (manifest as faster growth of wages above the taxable maximum) deteriorates the systems finances. The share of earnings covered under Social Security fell rapidly during the Clinton years (from about 87 to 83) even as employment and wages grew. It is better to have high employment and growing wages AND a greater share of earnings under the than one or the other.

         3. What share of earnings should fall under the cap is pretty much arbitrary--or to state differently it is a political choice. 90% was targeted by Congress in the early 80's. that was hardly the long term average. Far from it. Our current political system should make a choice what we want to target. You could even devise an indexing system that held the share constant over time (rather than increasing the tax max threshold to overall age growth).

  •  I've been of the opinion... (1+ / 0-)
    Recommended by:
    kurt

    ...that raising the cap significantly is worth the potentially very high benefit payments to certain very high salaried retirees. No matter what system "fix" we decide upon, a relative small handful of "somebodies" are going to have a seemingly unfair windfall.

    A "fix" that stabilizes the Housing market will probably result in a relative handful of homeowners who were underwater getting a big, fat capital gain because they were in the right situation at the right time.

    We need to do what's best for the vast majority of us and, acknowledge that some "collateral reward" will probably be visited upon a small number of people people who seem "undeserving."

    Occupy Wall Street AND K Street!!!!

    by Egalitare on Tue Nov 15, 2011 at 11:06:21 AM PST

  •  The correct remedy is to convert the FICA and (0+ / 0-)

    Medicare payroll taxes to taxes on all forms of income.  Currently, one can earn $100M in long-term capital gains and qualified dividends and not a pay a single dime in FICA or Medicare tax because FICA and Medicare are payroll taxes.  Making FICA and Medicare taxes on all forms of income would result in linear FICA and Medicare tax receipt growth with respect to GDP (i.e., a rising tide would truly lift all boats).  Currently, FICA and Medicare receipts are tied to salary and wage income.  Wage and salary income as a percentage of GDP fell to record lows under G.W. Bush, which meant that most of the gain in the GDP was not subject to the FICA and Medicare taxes.

    The GOP has become the "Jerry Springer" party.

    by ConcernedCitizenYouBet on Tue Nov 15, 2011 at 11:23:43 AM PST

    •  ACA changes Medicare tax (0+ / 0-)

      Under the ACA the Medicare tax will also apply to unearned income of high earners.

      The reason is that we need a lot more money for health care.

      BY contrast, we do not need a whole lot more money for Social Security. We may need a lot more money for other needs. So why target unearned incomes for Social Security when it changes the basic philosophy of the program (should I be able to contribute unearned income into my 401K?)

      •  The counter argument is why should (0+ / 0-)

        high-income workers have to bare the brunt of subsidizing low-income workers while the capital class gets a free ride?  The benefit paid at the top is not linear with respect to contributions.  Low-income workers receive a larger benefit per dollar contributed.  

        If we remove the cap on FICA contributions, are we going to lift the cap on Social Security benefits?  If we increase the contribution limit without increasing the maximum benefit, then Social Security becomes yet another welfare program that is funded by a backdoor income tax on work.

        With respect to 401K: well, that is yet another scam.  Why are 401K distributions taxed as ordinary income?  Granted, the original investment was made from untaxed ordinary income; however, 401K gains should be taxed as capital gains, not ordinary income.  The 401K tax code creates two classes of investor; namely, true investors and wage slaves who think that they are true investors.   True investors pay capital gains tax on stock and mutual fund sales.

        The GOP has become the "Jerry Springer" party.

        by ConcernedCitizenYouBet on Tue Nov 15, 2011 at 04:12:08 PM PST

        [ Parent ]

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