Tuesday, May 10, 2016

Smith: “Don't blame income equality for the fall of Social Security”

Writing for The Hill, Brenton Smith argues that it’s not rising income inequality that has reduced the share of total earnings subject to Social Security taxes and weakened the program’s finances.

Social Security’s hold on the wage base has declined over the last 30 years. The majority of that fall, however, occurred more than 25 years ago. It seems unlikely that income inequality in 2015 was a significant factor in wage-allocation during the 1980s.

The biggest drop in Social Security’s hold on wages occurred in 1987 and 1988.  These two years combine to account for nearly 50 percent of the overall fall in the system’s revenue base. By 1988, wages subject to FICA taxes had fallen below 86 percent of the total. Since that time, the figure has dropped to an average of 84 percent. So the trend is not current news.

Click here to check out the whole piece.

I agree that the tax reforms of 1986 had some illusory effect on Social Security financing: the reforms created incentives for high income households to report business income as personal income. While this may have been good policy, it caused an apparent skewing of the income distribution that probably didn’t reflect reality. It’s not as if these high-income households were receiving more money; they simply were reporting it in a form that plays into the Social Security policy debate.

That said, other factors were at play. One is rising health care costs, which reduce wages in ways that create the appearance of income inequality. (See my WSJ piece with Mark Warshawsky.)

And then, of course, there was actual income inequality, which I’m sure did increase but without accounting for the other factors we can’t be sure by precisely how much.

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