Income Inequality and the Trust Funds Shortfalls

Former Labor Secretary Robert Reich has an excellent column on his Substack explaining why the projected shortfall in the Social Security trust fund, which if left unaddressed by Congress could lead to a 20 percent cut in benefits in late 2032, is entirely due to rising income inequality in the U.S.

As he points out, you can’t blame the Baby Boom (the first post-WWII generation) for the shortfall. That was fixed in 1983 when Congress raised the payroll tax to its current level of 12.4 percent, which is split evenly between wage and salary workers and their employers. Congress also raised the retirement age.

The fix also renewed the cap on wages subject to the tax. Its level was set to tax about 90 percent of total income, which an annual inflation adjustment was meant to hold steady. The cap is currently $184,500.

Unfortunately, things didn’t work out that way. Today, the Social Security payroll tax only covers about 82 percent of total income. What happened over the intervening four-plus decades to cause the level of income taxed to fall?

It’s simple. The share of total income above the cap went from 10 percent of all income to 18 percent as upper income individuals, especially the very rich, grabbed a larger and larger share of the nation’s salary pie. As Reich pointed out, the total share of income for the top 1 percent of earners (it takes at least $700,000 a year to make it into our Second Gilded Age elite) has risen to more than 20 percent of total income compared to 11.6 percent in 1983.

Congress could instantaneously eliminate the shortfall by eliminating the cap. It would even generate enough revenue to raise everyone’s benefits by $200 a month. This would be a huge boon to lower-income retirees without other retirement income. The average beneficiary, who receives $2,071 a month in 2026, would get a nearly 10 percent raise. The beneficiaries with the highest incomes during their working years, who are more likely to wait until 70 so they can get the highest monthly payouts, would only receive a 3.9 percent increase on their $5,181 maximum benefit.

This is most Democrats solution to the Social Security shortfall. Legislation introduced by Democratic senators Bernie Sander and Elizabeth Warren would eliminate the cap for those earning over $250,000. They would also give everyone a $200 monthly raise.

Separate bills, sponsored by Sheldon Whitehouse (D-RI) in the Senate and Brendan Boyle (D-PA) in the House, would eliminate the cap for those earning over $400,000. Their bill doesn’t increase benefits. Both bills would guarantee trust fund solvency for at least 75 years.

As for Republicans, House Speaker Mike Johnson (R-La) announced their approach earlier this week. The current majority, if returned to Congress, will introduce its plan next year, he said.

“Entitlement programs like Medicare, Medicaid and then things like Social Security … have to be adjusted and fixed,” he reportedly said on the Moon Griffon show, which is a Louisiana-based podcast filled with rightwing, anti-gay, anti-trans, anti-environment and pro-war diatribes. I stopped listening for the exact Johnson quote after the host accused Democrats of being communists.

Given the GOP’s steadfast opposition to raising anyone’s taxes and fixation on giving endless tax breaks to the rich, Johnson was essentially signaling that they will either cut benefits or do nothing. The latter is essentially the same thing as cutting benefits if Republican remain in charge since the Social Security trust fund expiration date is now just six years away.

Rising inequality’s impact on Medicare

Income inequality is also eroding the Medicare trust fund, although not in the same way since the Medicare payroll tax, 2.9 percent equally split between worker and employer, has no cap. It is levied on all wages and salaries.

But what that tax misses (and this is true for Social Security as well) is that corporations are capturing a growing share of national income at the expense of their salaried and hourly workers. Corporate profits are not subject to the payroll tax. That means the relative size of the pie subject to the payroll tax is shrinking.

Two charts from the Federal Reserve Bank of St. Louis capture this shift:

The first chart shows the total share of income going to workers has dropped by four to five percentage points between 1983 and today. Over the same time period, the total share of income going to corporate profits has increased by four to five percentage points.

To sum up, the trust funds are levying their payroll taxes on a shrinking share (due to growing income inequality) of a shrinking pie (a greater share of total national income going to corporations).

This has a larger immediate impact on Medicare than on Social Security. Retirees are more or less guaranteed that their government pension benefit will rise at the rate of inflation. That is, they don’t suffer a loss of purchasing power.

The Medicare trust fund, on the other hand, pays for hospital care (the government’s share, not seniors’ out-of-pocket expenses). Hospital costs, like health care costs as a whole, have been rising at two times the inflation rate or more over the past four decades. There’s no way a flat payroll tax on a shrinking wage-and-salary pie could keep up with that kind of cost growth.

Finally, I would be remiss if I didn’t point out that unearned or so-called passive income like interest, carried interest for hedge funds, rents and dividends, also are not subject to payroll taxes. These, too, mostly go to the well-off.

Add it all up and what you have today is more than half of national income exempt from the taxes that support our two main retirement programs.

The tax cuts contained in the One Big Ugly Bill passed last year will hand out about $2 trillion to corporations and the well-to-do over the next decade. This will only make things much worse for the Social Security and Medicare trust funds, not to mention federal income tax collections and state income tax collections that are hitched to the federal tax code.

One can only hope Democrats on the campaign trail this year will make tax reform a major issue. Everyone’s financial security in retirement, whether old or young, depends on it.

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