by Teresa Ghilarducci and Alex Pavlakis
Though 94 percent of us (about 151 million workers) will pay our Social Security tax every paycheck in 2017, a handful of the highest income Americans will stop paying before you finish reading this blog. The over $2 trillion dollars of earnings that escape Social Security tax are an accident caused by the lopsided growth of income for the lucky few (about 9.6 million) earning over $120,000 or so per year.
The tax rate for Social Security (old age survivors and disability insurance OASDI) is 6.4 percent for both the employer and employee and is paid on earnings up to a cap. In 2016, the cap was $118,500. In 2017, the cap will increase to $127,200 in 2017 based on average wage growth. For those at the upper end of the income distribution (the top 1 percent, or the 2 million people earning more than $250,000 per year and the 137,000 people earning more than $1 million per year), $127,200 is a trivial amount on which to pay Social Security tax.
Take, for example, the top 9,600 or so wage earners who earned over $10 million per year (2015 is the latest data available). New Year's Day 2017 fell on a Sunday. By the time they finish their two weeks back at work, they will be done paying Social Security taxes for the entire year.
That is nothing. The 202 Americans who earned more than $50 million a year finished paying less than 5 hours after the ball dropped in Times Square. Another 773 people earning between $20-$50 million a year will finish paying the tax before you finish reading this blog on January 2nd.
This game - 'when do rich people stop paying for Social Security?'- could go on forever. We can have fun with the calculations: who will finish paying by their first coffee break of the day? After brushing their teeth? After their hangover? Keep in mind that in 1994, a bipartisan group of politicians eliminated the Medicare earnings cap. Since then, everyone pays Medicare taxes all year long. And since 2016, higher earners pay a surcharge. The Medicare tax is only 2.45 percent (combined employer and employee tax - the worker effectively pays the employers' portion).
Kathleen Romig at the Center for Budget and Policy Priorities argues that eliminating the cap would make up for the unanticipated growth in income inequality caused by the rapid increase in earnings above the cap and stagnation of earnings for the bottom 94 percent in the 1990s and 2000. Karen Smith at the Urban Institute lists raising the cap as a means to ensure Social Security's financial strength. Because raising the cap would mean only a few of the highest earners pay more, it is unlikely to inhibit overall economic activity. The richest people in America would not lose their place or social status or economic well-being. The largest effect would be that the retirement system for the bottom 99 percent of workers would be solvent until 2087.
We could also collect revenue for Social Security from income that is currently not counted as labor income. The richest 20 Americans - including 4 Mars candy family members and 3 Waltons - likely earn at least 6 percent per year in dividend, interest, and capital gains on their wealth, or $45 billion. The lowest 21 million earners also earned $45 billion. The top 20 earned $22 billion per year each on average and paid no Social Security tax. The bottom 21 million earned $2,000 per year each on average and paid 6.4 percent of Social Security tax. Because income from wealth is not considered wages, Social Security taxes are not paid. However, if these billionaires paid Social Security tax, the Social Security system would instantly have 10 percent more revenue.
We face a retirement crisis in America. We need comprehensive pension reform, but we also need to shore up and expand Social Security. The first step is to right the wrong of lopsided earnings growth and raise the earnings cap. We should also tax some financial capital to strengthen and expand Social Security. Solving the retirement crisis by shoring up pension income is the best policy idea in the New Year. Raising the cap is very little pain and all gain.
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WHY THE SYSTEM IS SHORT OF FUNDS
The boomers are not causing the system to run short of revenue in 2035. The system's actuaries anticipated baby boomers' retirement. In addition, the system is not bankrupt. Without increasing revenues, the system will generate revenue to pay 75 percent, rather than 100 percent, of promised benefits.
The main reason Social Security taxes aren't sufficient to pay full benefits is that the system did not anticipate the extreme growth of inequality in earnings and how much of wages would be diverted to pay health insurance back in 1983 when the Social Security tax was last raised by Congress and the President. The inequality of wage income is the most important reason for the short fall. Most of all, labor earnings growth since 1979 has gone to the top earners. When it comes to the pace of annual pay increases, the top 1 percent wage - the wage that escapes Social Security tax due to the cap - grew 138 percent since 1979, while wages for the bottom 90 percent grew only 15 percent. The unprecedented lopsided growth earnings are the main reason the system is in shortfall. The system can easily be made solvent if it adjusts to the reality of inequality.
Extreme earnings inequality explains the Social Security shortfall because Social Security taxes are only collected on incomes below an earnings cap. In 2016, the cap was $118,500 (which is indexed to average wage growth, not the wage growth at the top). Anyone who makes more than the cap stops contributing to Social Security as soon as they hit the earnings cap. For most of us, this does not matter. Last year, less than 6 percent of wage earners took home more than $120,000. Therefore, the vast majority of workers pay Social Security tax all year long.