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Anti-social Security

July 21, 2009

The Wall Street Journal (pay site) has an interesting line today on an old and growing problem—the widening gap between the folks at the top of the income pyramid and the rest of us.

Turns out the pay gap is part of what threatens Social Security.

To recap for those who have not been paying attention for the past two generations: in the United States, workers at the bottom two or three quintiles have seen their wages stagnate (or decline) since the early 1970s, while those in the top quintile have seen their incomes increase. The increases have been more dramatic as you break down that top 20 percent: the top 10 percent did better still; the top one percent way better than the nine percent just below them, and the top one tenth of a percent-the 300,000 or so Americans whose 2005 per capita income exceeded $1.7 million-have basically unmoored themselves from reality.

The best illustration of the nation’s income distribution can be found here. Remember, it’s not “class warfare” if it’s only the facts.

Anyway, so the WSJ has connected the pay of “top earners” to the problems of Social Security:

The growing portion of pay that exceeds the maximum amount subject to payroll taxes has contributed to the weakening of the Social Security trust fund. In May, the government said the Social Security fund would be exhausted in 2037, four years earlier than was predicted in 2008.

The problem is the “ceiling” on income subject to the Social Security tax. Those who earn below this magic number—currently $106,800—are encouraged to forget it exists. If you look at your pay stub, you can see that 6.2 percent of your earnings go to Social Security (your employer pays another 6.2 percent on your behalf). But every dollar you earn over that $106,800 limit is not subject to that tax. Plus, your employer can, and usually does, give you the 6.2 percent it would have paid to the feds. It’s another way the rich pay less in taxes than the poor. As the WSJ notes:

The data suggest that the payroll tax ceiling hasn’t kept up with the growth in executive pay. As executive pay has increased, the percentage of wages subject to payroll taxes has shrunk, to 83% from 90% in 1982. Compensation that isn’t subject to the portion of payroll tax that funds old-age benefits now represents foregone revenue of $115 billion a year.

The story doesn’t explain two things, one of which the commenters harp on over and over, and the other of which is overlooked. The thing lots of commenters note is that Social Security benefits are capped along with the cap on income taxed. That’s fair, they say, and raising the cap without increasing the benefit would be communistic. (Really, WSJ commenters are pretty adamant about stuff like this. They also assume that people who get paid $1 million a year, by definition, “earned” it, despite the evidence).

Overlooked in the story and the comments is the presumption under which Social Security was designed. I don’t mean the lower life expectancies common in the 1930s, ’40s and ’50s. I mean the higher marginal tax rates on the very wealthy. Although it’s mostly forgotten now, top marginal U.S. income tax rates exceeded 90 percent in the post-war period, and were still 70 percent until 1980. This was for income above $200,000-equivalent to about $500,000 today.

Although they were blamed for the “stagflation” that gripped the economy in the late 1970s (instead of the prosperity of the ’50s and ’60s), those kinds of confiscatory tax rates kept the country’s real income distribution much flatter than it is today, and in some ways made up for the cap on Social Security taxes (and Medicaid, which was capped until 1993).

Since 1980, the amount of money the very well-paid get to keep has skyrocketed, skewing everything from the luxury goods market to the housing market, while creating jobs for a whole class of “wealth managers” (see, for example A.I.G. and Bernie Madoff) that were nearly nonexistent in decades past. But the most interesting thing about the change has been the way the rich have perpetuated their style of “earning,” by awarding themselves raises far in excess of those enjoyed by their underlings. The WSJ explains how this “other” compensation goes mainly untaxed. The top six percent earned $2.1 trillion in 2007:

The $2.1 trillion figure understates executive pay, however, because it includes just salary and vested deferred compensation, including bonuses. It doesn’t include unvested employer contributions and unvested interest credited to deferred-pay accounts. Nor does it include unexercised stock options (options aren’t subject to payroll tax until exercised), and unvested restricted stock (which isn’t subject to payroll tax until vested; the subsequent appreciation is taxed as a capital gain).

It gets better, for the rich. And the story explains one reason why big corporations oppose a lifting of the Social Security cap. Turns out the cap itself provides them with a kind of loophole that allows them to lavish even more money on their top “earners,” and they do this to make up for the Social Security cap:

For example, health insurer Humana Inc. contributes 4% of pay to employees’ retirement accounts on salary up to the taxable-earnings wage base – and 8% above it. Thanks to the richer contribution, Humana Chief Executive Michael B. McCallister received a total contribution of $22,370 under the plan in 2008. (He also received $314,790 in company contributions to his supplemental executive retirement and savings plan.)

Typically, employers can’t discriminate in favor of high-paid employees who participate in taxpayer-subsidized retirement plans. But a “permitted disparity” exception enables them to provide additional benefits on the portion of pay that isn’t subject to payroll taxes, ostensibly to replace the Social Security benefits executives won’t receive on the portion of their pay that is exempt from payroll taxes.

That’s only fair, right?

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