Income Inequality Worsens Social Security Crisis

For most retirees, Social Security is a critical source of income, helping 80% to 90% of them make ends meet. However, this essential program is on increasingly shaky ground due to several demographic shifts, including a growing income inequality problem.

Demographic Changes Straining Social Security

Every year since 1985, the Social Security Board of Trustees Report has warned that long-term revenue collection won’t be sufficient to cover outlays, such as benefits and administrative expenses. In the 2023 report, the funding shortfall is estimated to be a staggering $22.4 trillion through 2097, and if not addressed soon, Social Security’s $2.8 trillion in asset reserves could be depleted, leading to significant benefit cuts.

Several demographic shifts are negatively impacting America’s top retirement program, including a significant decrease in legal immigration and historically low birth rates. However, the most prominent issue may be the program’s growing income inequality problem.

Income Inequality Hurting Social Security

Ideally, Social Security should generate enough annual revenue to cover its expenses. However, since 2021, the program has been spending more than it’s bringing in, depleting its asset reserves. The bulk of Social Security’s income comes from the payroll tax, which is a 12.4% tax on earned income.

The payroll tax applies to all earned income up to a maximum taxable earnings cap, which is $160,200 in 2023. Earned income above this threshold is exempted from the payroll tax. While 94% of working Americans earn less than this cap and pay into Social Security with every dollar they earn, the remaining 6% are exempted on any income above it. In 1984, 91% of all earned income was subject to the payroll tax, but by 2021, that figure had dropped to 81%. This income inequality problem is potentially “cheating” Social Security out of much-needed tax revenue.

President Biden’s Solution for Social Security’s Income Inequality Problem

Before becoming president, Joe Biden proposed a four-point plan to strengthen Social Security, with the key component being addressing income inequality. His proposal involved creating a “doughnut hole” between the maximum taxable earnings cap and the $400,000 threshold, reinstating the payroll tax on earned income above $400,000. This would generate additional revenue for Social Security, potentially delaying its asset reserve depletion date.

However, there are several catches with Biden’s proposal. First, an argument can be made that the rich are already paying their fair share, as both taxable earnings and monthly benefits at full retirement age are capped. Second, Biden’s plan may not do as much as expected to extend the solvency of Social Security’s asset reserves, as his proposed benefit increases would offset most of the additional revenue from taxing high earners. Finally, taxing the rich doesn’t have enough support in Congress to become law, as it would require bipartisan support, which is unlikely given Republican opposition to such measures.

It appears likely that Social Security’s income inequality problem will continue to worsen, spelling bad news for an already financially strained retirement program.