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Social Security Has a Growing Income Inequality Problem

By Sean Williams – Updated Sep 21, 2018 at 3:38PM

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A growing divide between the rich and everyone else is wreaking havoc on Social Security.

Social Security may be the most important social program in America, but it's also in some pretty deep trouble.

Social Security's long-expected problems come to a head

According to the latest annual report from the Social Security Board of Trustees, the program has finally hit a long-expected inflection point. For the first time since 1982, the program is forecast to expend more than it collects in revenue. Even though we're only talking about a relatively minuscule net cash outflow of $1.7 billion, which is hardly a blip on the radar next to nearly $2.9 trillion in the Trust's asset reserves, it's the simple fact that costs are beginning to exceed revenue that's scary.

Dice and casino chips lying atop Social Security cards.

Image source: Getty Images.

Though 2019 may demonstrate a slight reprieve for this net cash outflow, it's expected to balloon rapidly in 2020 and beyond. By the time 2034 rolls around, a multifactored demographic change is expected to have completely exhausted Social Security's asset reserves.

The good news? Social Security is in no danger of going bankrupt. Even without any excess cash, the program's noninterest revenue -- i.e., its 12.4% payroll tax on earned income, and the taxation of benefits -- will ensure that money continues to flow in for disbursement to eligible beneficiaries.

The downside? An ongoing net cash outflow that leads to asset reserve depletion confirms that the current payout schedule isn't sustainable. Should lawmakers on Capitol Hill not figure out an amicable solution to raise additional revenue and/or cut costs, the Trustees opine that an across-the-board benefit cut of 21% may be needed by 2034 to sustain payouts over the long term (defined as 75 years, through 2092). That's not a very rosy forecast considering that just over three out five current retired workers rely on their monthly check to provide at least half of their income.

Often, baby boomers and increased longevity are blamed for crippling Social Security. Boomers, through no fault of their own, are hitting retirement age (and the eligible age to claim a retired worker benefit from Social Security) and leaving the workforce. This is weighing down the worker-to-beneficiary ratio. We've also seen the average life expectancy from birth increase by about nine years since 1960. This allows retirees who make it to the Social Security claiming age to receive a benefit for a longer period of time than, say, their parents or even grandparents.

A visibly annoyed senior man in a suit with a scowl on his face.

Image source: Getty Images.

Income inequality is wreaking havoc on Social Security

While these demographic shifts are changing the dynamics of the program, they really aren't "to blame" for Social Security's projected $13.2 trillion cash shortfall between 2034 and 2092. Instead, a big wag of the finger should be directed at growing income inequality in the United States.

According to a recently released paper by the Economic Policy Institute, a nonpartisan, nonprofit think tank in Washington, D.C., income inequality in the U.S. has been steadily worsening at the state level since 1973. In 2015, the average income of the top 1% of the population was 26.3 times the average income of the bottom 99%. More recently, between 2009 and 2015, the incomes of the top 1% grew faster in 43 out of 50 U.S. states. 

The problem with income inequality and Social Security is twofold.

First, it creates a revenue collection issue. The reason? Social Security's 12.4% payroll tax on earned income (wages, interest, and dividend income) is only applicable up to $128,400 in 2018. Although this figure typically rises in step with the National Average Wage Index on a percentage basis, it still allows the upper echelon of wage earners to escape with some or most of their income being exempt from the payroll tax. Per the Social Security Administration, the amount of earnings exempted from the payroll tax has quadrupled from about $300 billion in 1983 to around $1.2 trillion in 2016.

A chalkboard drawing of a seesaw with a rich stick figure surrounded by dollar signs on one side, and a family of stick figures with question marks above their heads on the other side.

Image source: Getty Images.

The second problem is that the well-to-do don't have the same financial constraints as lower-income individuals and families may encounter when it comes to getting preventative medical care and medicine. Though the passage of the Affordable Care Act helped for a short time, the fact remains that being able to receive (and pay for) medical care has allowed the life expectancies of wealthier individuals to handily outpace that of lower-income folks. This means the rich are receiving a Social Security benefit for an extended period of time, and that this benefit, as a result of their higher annual income over their lifetime, also happens to be larger than that of the average American. That's an under-the-radar, but nevertheless significant strain on the program.

Eliminate the payroll tax cap? Not as easy as you might think

The most logical fix to this mess, at least from the perspective of partially leveling out the playing field, would be to raise or eliminate the maximum payroll tax cap (the aforementioned $128,400 level at which earnings become exempt). Removing this cap entirely and exposing all earned income to the payroll tax -- a core proposal of Democrats on Capitol Hill -- would likely eliminate Social Security's $13.2 trillion cash shortfall.

What's more, removing or raising the payroll tax cap is overwhelmingly the most popular solution with the American public, according to numerous surveys. That's because around 90% of the public is already paying into the program with every dollar they earn, meaning removing or raising the cap would only affect a small percentage of the population.

The facade of the Capitol building in Washington, D.C.

Image source: Getty Images.

But eliminating or raising the payroll tax cap isn't as easy of a fix as it sounds. For starters, there are politics that would need to be worked around. No legislative changes can be made to Social Security without 60 votes in the Senate -- and there hasn't been a supermajority (i.e., 60 seats held by one party) in the Senate in four decades. Flat out, Republicans are highly unlikely to work with Senate Democrats on passing a fix that only raises additional revenue without affixing long-term spending cuts as well.

The other problem is that the maximum tax cap exists today because there's also a maximum benefit that the Social Security Administration will pay out at full retirement age of $2,788, as of 2018. This maximum retirement benefit and maximum payroll tax cap sort of go hand in hand. Removing the tax cap without the well-to-do receiving any extra in benefits from Social Security during retirement could be a tough sell.

In short, something needs to be done with income inequality. But what that "something" is remains to be seen.

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