Is salary inequality harming social security? | Smart Switch: Personal Finance

(Maurie Backman)

Millions of seniors today rely heavily on Social Security to cover their living expenses. That’s despite the fact that beneficiaries have been losing purchasing power for years as inflation has outpaced Social Security increases.

To make matters worse, there is the possibility that social security cuts In the not too distant future. The program’s trust funds could run out of money in about a decade. Once that happens, benefits could be greatly reduced in the absence of adequate income.

A large part of the problem stems from the fact that baby boomers are leaving the workforce at a rapid rate. Since payroll tax revenues are the main source of funding for Social Security, lower labor force participation rates could put the program in a financially fragile position.

But that is only part of the problem. What’s also problematic is the method by which payroll taxes are imposed, and the fact that they tend to tax those who earn less than the wealthy much more.

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When pay inequality rears its ugly head

Workers pay 12.4% Social Security income tax that is divided into two parts among salaried employees, the workers themselves pay 6.2% and employers pay the second half of that account. Those who are self-employed must cover the entire 12.4%.

That tax, however, does not apply to all earnings. Rather, an annual salary cap has been established that dictates the thresholds at which payroll taxes are levied. This year, that limit is $147,000.

What this means, however, is that many high-income earners pay very little payroll tax relative to their total earnings. Meanwhile, people with lower incomes commonly pay Social Security taxes on their full Profits.

But in recent years, wage growth among the lowest earners has stagnated compared to wage growth among the highest earners. And since 1983, the share of untaxed earnings has risen sharply from 10% to nearly 17.5%, according to the nonpartisan Center for American Progress. As a result, Social Security has lost a world of income, income it needs to keep up with scheduled benefits.

Address the issue at hand

To address Social Security’s looming funding shortfall, lawmakers have proposed raising or eliminating the salary cap so that higher earners pay more Social Security taxes on their income. This year, someone making $147,000 pays the same amount into Social Security as someone making $3 million, so getting rid of the salary cap or raising it substantially could end what many consider to be an extremely unfair system.

But it’s also important to remember that while higher earners don’t pay Social Security taxes on earnings beyond a certain point, earnings above the salary cap also don’t count toward benefits, which are based on the salary. So if a higher threshold is set for payroll taxes, it will be difficult for Social Security not to readjust its formula to account for higher wages when determining which benefit recipients are in line.

The end result could end up being a washout. Social Security could see your income increase by taxing earnings at a higher level. But if you then have to pay higher earners a more generous benefit in retirement, the program really doesn’t pan out.

Of course, there is always the option of taxing wages above the cap, but keeping the maximum profit How is it. But that’s a solution unlikely to sit well with the wealthy, who tend to be politically influential.

All that said, there really isn’t a great solution to Social Security’s financial problems. But with any luck, lawmakers will at least start exploring ways to ease the payroll tax burden on low-income workers.

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