How Income Inequality Has Hurt Social Security

Inequality has been front and center this political season, but one relatively unexamined aspect of the problem is the way it has exacerbated the financial distress of Social Security. As work by Monique Morrissey at the Economic Policy Institute shows, the spike in income inequality in recent decades accounts for as much as half of the program’s long-term financial shortfall.

This is because the payroll tax meant to fund Social Security is capped: The tax currently applies only to income below $110,100 a year, while any dollar an individual makes over that amount is not subject to the tax. So the growth in inequality since the late 1970s has pushed ever more income out of the reach of the payroll tax. When the formula for setting the cap was reformed in 1983, only 10 percent of earnings in the country escaped the tax. By 2008, that had grown to 16 percent:

Restoring the taxable earnings cap to cover 90% of earnings would close 31% of the projected shortfall. Add in forgone revenues and interest from 1983 to 2008, and the trust fund would now be larger by over $850 billion, equal to 16% of the $5.4 trillion shortfall. All told, growing inequality accounts for roughly half (47%) of the projected shortfall that has emerged since the system was last restored to balance.

Eliminating the cap entirely would close 71 percent of the shortfall, even if benefits for higher income earners are increased to reflect their greater contributions.


Another way to tackle the question: What if the cap had remained the same as it is, but inequality had not taken off? Which is to say, what if wage growth had maintained its historic connection to productivity growth, instead of decoupling since the 1970s, and median wages had not stagnated?:

If real wage growth had kept up with productivity from 1983 to 2007, the trust fund would now be larger by roughly $450 billion, equal to 8% of the $5.4 trillion shortfall. Going forward, the Social Security actuaries project relatively slow wage growth of 1.2% above inflation, but wage growth of 1.8% above inflation (the average productivity growth rate over the past quarter century) would eliminate 43% of the projected shortfall, according to the trustees’ 2010 report. All together, then, slow wage growth accounts for roughly half (51%) of the projected shortfall that has emerged since the system was last restored to balance.

In other words, America’s failure to maintain policies that support the wages of middle and lower-income Americans has contributed significantly to Social Security’s decline.

Meanwhile, increasing the retirement age or cutting benefits ignores the reality that Americans in the lower half of the income distribution missed out almost entirely on the gains in life expectancy, and that Social Security benefits as they currently stand kept 13.8 million seniors out of poverty in 2010.