Low Wage Purgatory

At the time, the youngest baby boomers were 19. So all of the experts were fully aware of the demographic statistics now cited by President George W. Bush as the root cause of Social Security's shortfall: that the ratio of workers to retirees would plunge from 16 to 1 to 2 to 1 when the last boomers retire decades hence. To eliminate the deficit this would create, the commission suggested hiking the Social Security payroll tax and lifting the retirement age to 67 by 2026. Congress promptly passed legislation doing just that, and President Ronald Reagan signed it.

A new study sheds light on what happened since 1983 to bring back the shortfall, which is projected to be $4 trillion over the next 75 years. Two major economic shifts occurred that Greenspan's commission didn't anticipate: The growth of average U.S. wages slowed, and income inequality soared. Together these trends explain 75% of the reemergence of Social Security's long-term deficit, according to a paper by L. Josh Bivens of the Economic Policy Institute in Washington.

The upshot: Democrats and Republicans alike may be trying to solve the wrong problem. Rather than focusing on how many workers will be around to support retired boomers, some experts think the logical response is to recapture the revenue lost as rising inequality lifted a greater share of aggregate U.S. wages out of the reach of the 12.4% Social Security payroll tax. This year the taxable income level has been set at $90,000 a year. But the unanticipated spurt in inequality pushed more Americans over that amount. Because Social Security has forgone this extra revenue, it now taxes only 85% of collective payroll earnings, not the 90% that Greenspan and the commission had intended it to. If Congress put the aggregate taxable income level back to 90%, it would eliminate fully 40% of the deficit (or 75% under the smaller shortfall projected by the Congressional Budget Office). The progressive benefit cuts Bush endorsed recently would also remedy the problem, though they may be overly broad, sweeping in even those making as little as $25,000 a year.

True, taxing higher incomes would be painful to big earners. A 90% level would put individual taxable income as high as $140,000 a year today. So anyone making that much or more would be on the hook for an extra $3,100 in annual Social Security taxes, as would their employers. The hit to their wallets could hurt small-business owners, possibly dampening job creation, warns David C. John, a research fellow at the conservative Heritage Foundation who supports Bush's private accounts. Still, high earners would also get higher Social Security benefits when they retire. Liberal economists also point out that if Greenspan's design had worked, affluent Americans would have been paying at the higher level for two decades anyway. "It would be nice to reverse inequality, but meanwhile it makes a lot of sense to restore the tax cap," says Dean Baker, co-director of the Center for Economic & Policy Research in Washington.

No one can blame Greenspan for not anticipating the return of inequality to levels not seen since the Great Depression. Still, his commission's fix barely lasted a year. By 1984, Social Security had slipped back into deficit, where it has remained ever since. What happened? The program's cash intake has been caught in a crunch caused by the interaction of slower average wage growth and heightened income inequality, says Bivens.

Every year the Social Security Administration (SSA) adjusts the taxable wage level in tandem with the growth in the average U.S. wage base. So if average payroll growth slows, the annual adjustment in the wage cap does, too -- which is what has happened in the past 20 years. The Greenspan commission assumed that wages would grow at an average long-run pace of 1.5% a year. Today the SSA's Office of the Actuary has chopped its assumption to 1.1%, which compounds to a dramatic slowdown over 75 years.

Escaping the System

At the same time, rising inequality has lifted a greater share of wages above the taxable amount. So while sluggish wage gains have slowed the increase in the cap, faster pay growth at the top has allowed a greater share of overall income to escape the system. "No one anticipated this in 1983," says SSA Chief Actuary Stephen C. Goss, who worked with the Greenspan commission as a young staffer in the actuary's office.

Goss says that while his office sees the rise in inequality slowing a decade from now, the long-run trend isn't likely to ever reverse. So if nothing is done, the 85% of all wages taxed today will slip to 84%, says Goss -- and hover there for decades to come.

Seen in this light, Social Security's long-run problems seem more fixable. In fact, they may partly fix themselves: The boom of the late 1990s lifted average payroll growth back up to 1.4% a year since 1995. If Congress decided to restore the taxable wage level to 90%, it wouldn't make sense to try to recapture all the billions Social Security lost as the cap sank over the past 20 years; that would entail impractical moves such as retroactive taxes. But it could alter the formula for future years by linking it to a fixed share of payrolls. Even if high earners are given extra benefit payouts, the additional tax raised still would plug 40% of the long-run deficit because every extra dollar of Social Security tax results in less than a dollar of additional retirement benefits.

A look back at the Greenspan commission shows that Social Security's problems are economic, not demographic. From this standpoint, private accounts that cut benefits for middle-class Americans don't address the real issue. In debating how to fix the system, we first need to understand what's broken.