SouthernWorldwide.com – The financial difficulties facing Social Security are often attributed to demographic shifts, such as an aging population and declining birth rates, which result in a smaller workforce supporting a larger number of retirees. However, increasing income inequality is also significantly contributing to the program’s fiscal strain.
In recent decades, the earnings of high-income earners in the U.S. have dramatically outpaced those of middle and lower-income workers. This trend poses a challenge for Social Security because the program taxes annual earnings only up to a certain limit, which is currently $184,500. Consequently, a substantial portion of the accelerated income growth among top earners escapes taxation by the program.
The latest report from Social Security’s trustees indicates that this situation is leading to an erosion of the program’s revenue base. The proportion of total wages subject to Social Security taxes has decreased from nearly 87% in 1984 to approximately 83% today. This decline is primarily a result of high earners’ incomes growing much faster than those of other workers, pushing more of their earnings above the taxable maximum, according to the report.
“The Social Security trust fund is under strain because Congress has failed to update the program for the economy we actually have,” stated Elizabeth Wilkins, CEO of the Roosevelt Institute, a progressive think tank, in a recent address. She elaborated that too much income is currently accumulating at the top, thereby avoiding Social Security taxation.
One proposed solution to address Social Security’s financial shortfalls involves eliminating the $184,500 tax cap. Policy experts suggest that this measure could strengthen the program’s finances by requiring high-income individuals to contribute more towards supporting the retirement and disability system.
Without significant reforms, the Social Security trust fund is projected to become unable to meet its obligations by the end of 2032. If this occurs, the approximately 70 million beneficiaries would face a 22% reduction in their monthly Social Security payments, an average decrease of about $500 per month. Such a scenario, according to experts, would lead to widespread financial hardship for seniors, individuals with disabilities, and the surviving families of deceased workers.
Social Security has encountered financial challenges in the past. In the early 1980s, its trust funds were nearing insolvency due to economic instability experienced in the preceding decade.
How Inequality Is Weakening Social Security
In 1983, U.S. lawmakers implemented significant changes to Social Security. These included a gradual increase in the retirement age and adjustments to payroll taxes. While the tax cap on wages is annually adjusted for inflation, it was not modified in the 1983 reforms to account for subsequent shifts in the labor market.
This oversight was likely based on projections at the time that anticipated a continuation of wage distribution and growth patterns similar to the past. The actuarial projections guiding Congress in the 1980s assumed that the program would continue to tax roughly 87% of wages for the next 75 years, as detailed in a January report by the Roosevelt Institute.
However, as higher earners’ incomes surged ahead of those of other Americans, a greater portion of their earnings began to fall outside the scope of the Social Security payroll tax, according to the Roosevelt Institute’s analysis.
The Roosevelt report indicated that real earnings for the top 6% of American workers increased by 62% between 1983 and 2000. In contrast, the remaining 94% of workers, whose incomes remained below the payroll tax cap, experienced average real earnings gains of 17%.
The Roosevelt Institute posits that the trust fund has been “inadvertently starved of necessary revenue” since 1983.
Removing the Tax Cap
The tax cap, which has been a feature of the program since its inception in the 1930s, is frequently discussed in proposals aimed at strengthening Social Security. Some of these proposals suggest a gradual phase-out of the cap over time. Others advocate for a “donut hole” provision, where earnings between $184,500 and a higher threshold, such as $250,000 or $400,000, would not be subject to payroll taxes, with the tax resuming above that higher limit.
Under such a system, income within the “donut hole” would be exempt from payroll taxes, but taxation would recommence for earnings exceeding the upper income threshold.
According to the Social Security Administration’s scoring of these proposals, eliminating or phasing out the tax cap could potentially close between 22% and 67% of the program’s projected funding gap.
An alternative approach suggested by the Roosevelt Institute involves incorporating automatic triggers that activate when revenue falls below projections. For example, if the proportion of wages subject to Social Security taxes drops below 87%, the taxable maximum could automatically adjust to maintain that share.
“Social Security is a very strong program that can be fixed,” commented Joel Eskovitz, a senior director of Social Security and savings at the AARP Public Policy Institute, during a recent conference call discussing the program’s funding challenges. He added that “Most Americans want it to be fixed by not cutting benefits.”
