Increased Wage Inequality Has Reduced Social Security’s Revenue
Increased Wage Inequality Has Reduced Social Security’s Revenue
Rising economic inequality has pushed down Social Security’s revenues, but there are a few possible avenues to generating more revenue in order to preserve Social Security.
In 2020 and 2021, the federal government provided extraordinary direct aid to individuals in order help them through the economic shocks of the pandemic. But the largest source of financial stability during this crisis was, as always, Social Security. Approximately 65 million retirees, disabled workers, and survivors of deceased workers receive Social Security checks every month. This includes roughly 9 out of 10 elderly Americans. While the highest wage earners have more ability to save and invest for retirement, many low- and middle-income families do not have this luxury and find themselves extremely dependent on Social Security’s monthly payments.
Social Security benefits are paid from dedicated trust funds that are funded predominantly by payroll taxes. Those trust funds are sufficient to pay all benefits until 2034, according to the program’s trustees, but only about three-quarters of benefits after that. However, rising wage inequality is reducing Social Security revenue, thus increasing this long-term shortfall.
Growing wage inequality reduces the revenue flowing into Social Security because of how the Social Security payroll tax is structured. Nearly all of the program’s revenues come from a federal payroll tax of 12.4 percent on workers’ first $147,000 of annual wages. Payment of this tax is split in two, with the first 6.2 percent paid by employees and the second 6.2 percent paid by employers. The self-employed pay both halves of this tax. For many working-class people, this is a real burden: Nearly 2 in 3 Americans pay more in payroll taxes than in income taxes.*
Yet, because wages above the $147,000 maximum go untaxed, the relatively few workers who earn more than that are essentially exempt from Social Security taxes after they reach the maximum. A CEO with a $1 million salary, for instance, would have only contributed to the Social Security system through February 23 of 2022.
The taxable maximum (or cap) rises in line with average wage growth every year. But because average wages have grown more slowly than those at the top of the distribution, the share of wages above the taxable maximum has increased. Since 1983, the share of untaxed earnings has risen from 10 percent to almost 17.5 percent. This dramatic increase means that the Social Security payroll tax misses a substantial and growing amount of potential revenue.
Moreover, this increase is not being driven by some large mass of upper-middle-class workers. As shown in Figure 1, it is mostly due to a significant increase in the wage share of the top 1 percent. Between 1983 and 2020, the share of earnings going to the highest percentile of wage earners rose from 8.8 percent to 13.5 percent—an increase of 4.7 percentage points.** The greater share of wages going to the top 1 percent thus single-handedly accounts for 62 percent of the increase in untaxed earnings.
Low- and middle-income earners—who benefit more from Social Security—pay the full tax on their entire salaries. However, high-wage earners do not. This makes the payroll tax deeply regressive. High-wage earners have greater potential to invest and save for retirement, whereas low- and middle-wage earners do not have the same luxury, forcing them to rely more heavily on Social Security. Therefore, it is counterproductive to deprive Social Security of revenues precisely when wages decline for those most in need.
Share of Social Security’s 75-year funding shortfall eliminated
if the payroll tax cap is eliminated
if earnings above $250,000 are taxed
if earnings above $400,000 are taxed
Source: Zhe Li, "Social Security: Raising or Eliminating the Taxable Earnings Base" (Washington: Congressional Research Service, 2021), available at https://crsreports.congress.gov/product/pdf/RL/RL32896. Notes: The first two options assume an implementation date of 2022 and no change to the Social Security benefit formula. The third option assumes an implementation date of 2023 and a wage replacement rate of 2 percent for the newly taxed earnings.
Applying the Social Security tax to the wages of the highest earners would generate more revenue and make the payroll tax more equitable:
- Eliminating the payroll tax cap while not changing Social Security’s benefit structure would close approximately 73 percent of the program’s long-run funding shortfall.
- Subjecting earnings of more than $250,000 to the payroll tax would generate $1.0 trillion in additional revenues over the next decade and would eliminate 70 percent of Social Security’s 75-year funding shortfall.
- Applying the payroll tax to wages in excess of $400,000—as proposed in the Social Security 2100 Act—would impact just 4 percent of wage earners. The Congressional Research Service—citing estimates from the Social Security Administration—has reported that a highly similar proposal would eliminate more than three-fifths of Social Security’s long-run funding shortfall.
In an era of rising inequality, making the Social Security tax less regressive is the most obvious way to bolster the program and address its long-term shortfall. Nothing could be more perverse than declaring that, because the wages of the rich increased, benefits for the poor ought to decrease. Yet, without reforms to the taxable maximum, that’s exactly what will happen.
*Authors’ note: This mostly but not exclusively reflects the burden of the Social Security payroll tax, which accounts for about three-quarters of all federal payroll tax revenue. This analysis assumes that the entire payroll tax burden (including the half paid by employers) falls on workers.
**Authors’ note: In both 1982 and 1983, approximately 10.0 percent of wages were above the Social Security payroll tax cap, though the share was slightly lower in 1983 (9.974 percent) than in 1982 (9.976 percent). If we instead use 1982 as our baseline, the greater share of wages going to the top 1 percent accounts for 66 percent of the increase in untaxed earnings. For 1990–2020, the authors’ data on the wage share of the top 1 percent are based on data from the Social Security Administration (SSA). The authors estimated the correlation between the SSA series and the Piketty-Saez series from 1990–2011, then used the Piketty-Saez series to extrapolate the SSA series back to 1982.
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Research Associate, Inclusive Economy
Former Policy Analyst, Tax and Budget Policy