Is Social Security Hurt By Income Inequality?

As America recovers from the recession, wealthy households are recovering faster than low-income ones, whose incomes have stagnated or declined since the crash. A new report says that this widening gap is sapping Social Security.

Currently, two-thirds of seniors rely on the program for their retirement income. The wage gap may have cost Social Security$1 trillion over the last 30 years, according to a report last week from the Center for American Progress.

And as more Americans reach retirement age, Social Security is set to eat through its funding by 2033, assuming that Congress takes no action to bolster it. After that it would only be able to cover 77 percent of its claims.

"For low-income seniors, Social Security represents nearly 85 percent of income. Even for seniors right in the middle, Social Security represents nearly two-thirds of their retirement income," said Rebecca Vallas, director of CAP's poverty program.

Small wages, big shortfalls

The pension and disability insurance program is funded by a payroll tax that applies to wages of $118,500 and below. But the money flowing into the program is not as large as it could be, according to the report, now that an increasing share of wage growth is going to people who make more than that, and low-wage workers make less.

Why does that matter for Social Security? Because highest earners reach the $118,500 "cap" quickly and stop paying into the fund for the rest of the year. "Social Security funding is directly tied to the full wages of low and middle income workers," Vallas says. "It's their wages that matter."

The payroll tax cap was set in 1983 by President Reagan, which at the time captured 90 percent of wages. "Reagan essentially said, let's go for 90 percent, and we will let 10 percent go," says Vallas.

But since 1983, that cap hasn't been adjusted for wage growth to keep up with the 90 percent goal. "What they didn't anticipate is income inequality," says Vallas. "The highest earners have seen growth much faster than the average worker."

Now the tax cap only captures 83 percent of wages, instead of 90. The missing 7 percent is part of the Social Security shortfall.

"When you do the math, you're just not capturing as much in taxes as before. Seven percentage points doesn't seem like a lot – but it's a whole lot," says Philip Moeller, author of "Get What's Yours: The Secrets to Maxing Out Your Social Security," who notes that the gap adds up to billions quickly.

Closing the gap

CAP's study examines what would have happened if the taxable wage base had remained at 90 percent between 1983 and 2013, and found that there would be $1 trillion more in the fund, reducing its projected 75-year shortfall by 10 percent.

Freezing the taxable wage at 90 percent today alone would close one-quarter of the projected shortfall. CAP's brief finds that in 2015, earners making $1 million in wages reached their max last week on Feb. 12 and have stopped contributing for the year.

Average workers contribute all year long, but those at the bottom of the income spectrum have seen their wages decline since the recession, so there's less money going into the pot. Since 2013, the top 1 percent of earners took home almost the same share of total wages as the entire bottom half of workers, shifting income away from those whose full earnings are subject to payroll taxes.

Still, low-income earners receive a higher percentage of their wages back in the form of benefit payments than high earners do, and in this way Social Security is already a "progressive" policy, says Moeller.

He point out that critics leave the impression that rich people are getting something for free from Social Security, which is not the case.

"The implication in the CAP report is that a person who reaches the cap in February is somehow taking advantage of people or getting away with something for free," says Moeller. But in fact, they pay into the system like everyone else.

Addressing retirement crisis

Conclusions to be drawn from the study are that any policies that help boost wages for average workers will not only help struggling families make ends meet, but also help Social Security.

"While policymakers cannot undo the past," said report author and CAP Vice President Carmel Martin, "they can take action to improve Social Security's fiscal outlook by implementing policies that boost wages, combat rising inequality, and modernize the program's revenue structure to reflect today's economy."

Vallas has full confidence that Social Security will not become insolvent, but stagnant and declining wages for average workers could lead to a "double whammy" for low-income earners who are struggling with the day-to-day and can't put aside much for retirement.

"We are seeing a retirement crisis," says Vallas. "Folks are struggling to make ends meet for today and aren't putting anything away for tomorrow." The median retirement savings for working people is $3,000, and it's not much better for those nearing retirement.

"People will need to rely on Social Security," she says.

Email: laneanderson@deseretnews.com