Kuttner on TAP: The Coming Social Security Clash

Key Republican senators and House leaders have proposed cutting Social Security or subjecting its spending to an annual vote, citing budgetary needs. This would seem to be political suicide. Voters care a lot more about keeping their benefits than about fiscal details. Yet Democrats would be foolish to ignore the projected shortfalls in the Social Security trust funds, which undermine confidence in the program.

One reason for Social Security’s financial crunch, which has gotten almost no attention, is the worsening income distribution and the lousy pay for so many workers. Social Security is financed by payroll taxes on earnings. Reforms in 1977 and 1983 aimed to stabilize Social Security finances. Sponsors of the reforms targeted about 90 percent of wage and salary earnings as income to be taxed, roughly the same percentage of earnings that was taxed when the program began in 1937.

The system briefly hit that 90 percent target in the early 1980s. Then, as the rich got richer, the percentage of earnings covered by payroll taxes steadily declined. It dropped another 2.1 percentage points between 2019 and 2022 to just 81.4 percent, to its lowest level since the 1960s. (Thanks to Josh Bivens of EPI for pointing this out.)

The difference between the current 81.4 percent and the 90 percent target is almost $100 billion a year in lost Social Security revenue, a figure that will only grow.

Every year, the income cap on taxable earnings is raised to compensate for inflation. In 2023, because of the high inflation in 2022, the income cap will be increased from $147,000 to $160,200. But this increase is no match for widening income inequality, as more and more of the nation’s total wage and salary income goes to people who make a lot more than $160,000.

There are a couple of fixes to this problem. We could get rid of the cap so that all earned income is subject to Social Security taxes, as Congress did with Medicare taxes in 1993. Even better, we could subject capital income as well as wage income to Social Security taxes.

Even so, the payroll tax is a regressive tax. It’s regressive in three respects. It is levied on the first dollar of income with no exemptions or deductions, in addition to failing to fully tax incomes of affluent earners. And as a tax on payrolls, it increases the cost of creating new jobs.

A more radical solution, proposed by the tax scholar Reuven Avi-Yonah, would be to replace all or part of Social Security taxes with value-added taxes. In general, liberals oppose VATs as regressive. But Avi-Yonah’s version would offset the regressive aspects in three respects—with higher progressive taxes on high incomes; use some of the VAT proceeds to finance Social Security and other progressive outlays like universal health coverage; and use part of the VAT revenue to reduce the payroll tax load and make remaining payroll taxes progressive by ending the income cap and exempting the first $100,000 of income.

Neither of these proposals is likely to be enacted anytime soon. But when Republicans point to the Social Security shortfall (which is real) and propose cuts in benefits, Democrats need compelling alternatives—to embarrass Republicans and make the system financially healthy in a progressive fashion. The easiest short-term fix would be a big raise for workers.