Does wage inequality harm social security?

Today, millions of older people are heavily dependent on social security to cover their living expenses. This is despite recipients losing their purchasing power for years as inflation outpaced increases in Social Security.

Worse still, the potential for Social Security cuts in the not-too-distant future. The program’s trust funds could run out of money in a decade. Once this happens, the benefits could be reduced to a large extent in the absence of adequate income.

Much of the problem stems from the fact that baby boomers are leaving the workforce at a rapid rate. Since payroll tax revenues are the main source of funding for Social Security, declining labor force participation rates could put the program in a financially fragile position.

But that’s only part of the problem. What is also problematic is the method by which payroll taxes are imposed – and the fact that they tend to fall much more heavily on low-income people than on the wealthy.

Image source: Getty Images.

When wage inequalities point the tip of their nose

Workers pay a 12.4% social security tax on earnings which is split into two parts among employees, with workers themselves paying 6.2% and employers paying the second half of this tab. The self-employed must cover the full 12.4%.

This tax, however, does not apply to all income. Instead, there is an annual salary cap in place that dictates the thresholds at which payroll taxes apply. This year, that limit is $147,000.

This means, however, that many high-income earners get away with paying very little in payroll taxes relative to their total income. Meanwhile, low-income people usually pay social security taxes on their all earnings.

But in recent years, wage growth for low earners has stagnated relative to wage growth for high earners. And since 1983, the share of untaxed income has risen sharply, from 10% to nearly 17.5%, according to the nonpartisan Center for American Progress. As a result, Social Security has lost a world of revenue—the revenue it needs to keep pace with scheduled benefits.

Tackle the problem at hand

To address the looming Social Security financial shortfall, lawmakers have proposed raising or eliminating the salary cap so that high earners pay more Social Security taxes on their earnings. This year, someone making $147,000 pays the same amount into Social Security as someone making $3 million, so getting rid of the salary cap or raising it substantially could end what many see as a extremely unfair system.

But it’s also important to remember that while high earners don’t pay social security contributions on earnings beyond a certain point, earnings above the earnings cap don’t count toward benefits either. , which are based on wages. And so if a higher threshold for payroll taxes is established, it will be difficult for Social Security not to readjust its formula to account for higher wages when determining which benefits recipients are eligible for.

The end result could end up being a washout. Social Security could see its income increase by taxing income at a higher level. But if it then has to pay high earners a more generous retirement benefit, the program doesn’t really come out on top.

Of course, it is still possible to tax salaries above the ceiling, but keep the maximum benefit as is. But it is a solution that is unlikely to suit the wealthy, who tend to be politically influential.

All in all, there really is no good solution to Social Security’s financial problems. But hopefully lawmakers will at least begin to explore ways to ease the burden of payroll taxes on low-wage earners.

Previous Government debt yields climb on expectations of faster inflation
Next Group raises alarm over smear campaign plot against Emefiele