Monday, April 28, 2014

How Increases in Income Inequality Undermine Social Security

I spent several hours today working on a detailed example for my Inequality class, and thought that I would share it: 

Social Security retirement benefits are one of the most important things that prevents millions of elderly Americans from being poor.  Social security has been one of the most successful and most popular government programs in the past 80 years.
As the baby boom generation ages and reaches retirement age (which began in 2011) and as the size of the younger generation of workers becomes smaller, people begin worrying about the solvency of the social security program. The discussion often pits the interests of young people against the interests of the elderly - totally unnecessarily. 
It turns out that the biggest problem facing Social Security is NOT the disparity between the size of the elderly group and the size of the younger working group, the REAL problem with Social Security has been the increasing disparity in income between low paid workers and higher paid workers.  As wages for MOST workers have stagnated and declined in value while wages for a very tiny (about 10 percent of workers) have increased hugely  this has dramatically reduced the amount of social security taxes that would have been paid into the system.

Here’s how it works.  In 2014 all workers who make any income up to $117,000 must pay social security tax on the full amount of their income.  But a worker that makes $500,000 a year (a many upper middle class executives, bankers, lawyers, doctors, etc. do) only pays Social Security taxes on the first $117,000 and pay nothing at all (in Social Security ) on the other $383,000 that they make.  So let’s imagine two different business A and B, where A has low inequality, with higher pay for all workers, and less difference between lowest paid and CEO, and B has high inequality, with lower pay for all workers and large differences between lowest paid and CEO. 

Business A with Low Income Inequality, Ratio of Lowest Paid to Highest Paid is  17:1
Category of worker Number of persons at level Salary Range Average Salary Total Salary Paid by Business Total subject to Social Security Tax Total Social Security Tax Paid
CEO 1 $530,400
-
$530,400
$117,000
$14,508
Upper Management 10 $120,000 to $490,000
$214,000
$2,140,000
$1,170,000
$145,080
All other workers 5500 $31,200* to $115,000
$41,000
$225,500,000
$225,500,000**
$27,962,000
Total Salary Paid
$228,170,400
Total Social Security Taxes Paid
$28,121,588
*lowest hourly wage paid $16.00 an hour times 40 hours per week
**all of this income is subject to Social Security Tax because all workers make less than $117,000.


Business B with HIGH Income Inequality, Ratio of Lowest Paid to Highest Paid is  300:1
Category of worker Number of persons at level Salary Range Average Salary Total Salary Paid by Business Total subject to Social Security Tax Total Social Security Tax Paid
CEO 1 $4,212,000
-
$4,212,000
$117,000
$14,508
CFO, COO 2 $2,210,000 and $3,116,000
-
$5,326,000
$234,000
$29,016
Upper Management 8 $118,000 to $643,000
$302,000
$2,416,000
$936,000
$116,064
All other workers 5500 $14,040* to $100,000
$34,000
$187,000,000
$187,000,000**
$23,188,000
Total Salary Paid
$198,954 ,000
Total Social Security Taxes Paid
$23,347,588
*lowest hourly wage paid $7.20 an hour times 37.5 hours per week.
**all of this income is subject to Social Security Tax because all workers make less than $117,000.

In the first business the total compensation of the top 11 workers is $2,670,400, and the total Social Security Tax paid is $159,588.
In the second business the total compensation of the top 11 workers is $ 11,954,000,but the total Social Security Tax paid is still just $159,588 because only the first $117,000 is taxed.  Because workers paid less than $117,000 are paid less overall (lowest pay of company B is less than half that of Company A), the total Social Security taxes paid are lower.

The pattern found in Company A was typical in the 1960's in the U.S. albeit at lower dollar figures. Today's business pattern is much more like Company B. The result of thousands of businesses holding down income for the majority of workers while increasing the disparity of pay between those at the top and at the bottom, has had the overall impact of reducing the percentage of total salaries/wages that are subject to social security taxes. 

Businesses have multiple motivations to increase inequality in this way, the decrease total salary wage costs and decrease their share of Social Security taxes as well. The top workers are motivated because their additional income is not subject to Social Security taxes, and with the concurrent decline in upper bracket income taxes since the 1970's there is little income tax disincentive for additional income beyond the bottom of the highest bracket. In 2014 the highest income bracket begins at $ 406,751 for an individual and $457,601 for a married couple. So whether one's income is $500,000 or 5,00,000 the tax percentage is the same.  

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