Stagnant Wages Reason for Social Security Shortfall

"Wage Growth Continues to be the Key to Social Security Solvency"

Originally posted on July 24, 2015 by Dean Baker at the Center for Economic Policy Research

The 2015 Social Security trustees report again points to the importance of broadly based wage growth to the finances of the Social Security system. The 2015 report shows that the combined Old Age and Survivors Fund and Disability Insurance Fund will first face a shortfall in 2033, one year later than projected in the 2014 report. Taken separately, the Disability Insurance fund is projected to face a shortfall at some point in 2016.

The combined projected shortfall for the two programs is 2.68 percent of payroll over its 75-year planning horizon. This is down from a projected shortfall of 2.83 percent of payroll in the 2014 report. This improvement stems from a number of small changes in assumptions that more than offset the negative impact of adding a year of large projected deficits (2089) in place of a year of surpluses (2014).

Wage growth is the key to the program's solvency for two reasons. The first is that the upward redistribution of wage income over the last three decades has played a large role in the projected shortfall. As income has been transferred from ordinary workers to those at the top of the wage distribution, a larger share of wage income has escaped taxation. When the Greenspan Commission set the cap for taxable wages in 1983, it covered 90 percent of wage income. Currently the cap only covers around 82 percent of wage income. If the cap had continued to cover 90 percent of wage income, the projected shortfall would be roughly 40 percent less than it is now.

The other reason why broadly based wage growth is key to the program's continuing solvency is that the burden of possible future tax increases would be much less consequential if most workers will share in the gains of economic growth. The Social Security trustees project that real wages will rise by more than 34 percent over the next two decades. (They are projected to rise by another 30 percent over the following two decades.) Even if the payroll tax is increased by three percentage points, it would take back less than one-tenth of the projected rise in before-tax wages if wage growth is evenly shared. On the other hand, if most of the gains from growth continue to go to those at the top end of the distribution, any tax increase will be a major burden.

The weakness of the economy, in addition to the upward redistribution of income, has been the major factor in the immediate problems facing the disability insurance (DI) fund. The lower than projected wage growth, coupled with a large drop in employment associated with the collapse of the housing bubble, has lowered the revenue of the DI fund by more than $160 billion over the seven years compared with the projections that had been made before the downturn. While the DI program was projected to face problems even before the recession, had growth continued as projected it would have been able to pay full scheduled benefits until 2025.

While many politicians have tried to imply there is some fundamental problem with the structure of the DI program, it is clear that full funding can be maintained with minor fixes, such as reallocating revenue from the Old-Age and Survivors Insurance program. The financial health of both programs as they are now designed will depend on the prospect for maintaining high levels of employment and wage growth.

It is worth noting that in spite of the impact of the Great Recession on the revenues of both Social Security and Medicare, the finances of the two programs taken together have improved enormously in the Obama presidency, primarily due to the lower projected rate of increase of health care costs. In 2008, the combined shortfall for the two programs over their 75-year planning horizon was equal to 2.21 percentage points of GDP. The combined shortfall for the 75-year planning horizon in the 2015 report is just 1.26 percentage points of GDP. This improvement comes in spite of the fact that the 2015 projections include 7 additional years of large projected deficits (2083-2089).

It is remarkable that this improvement in the projected finances of these programs has not received more attention. It would be politically difficult to enact a combination of revenue increases and benefit cuts that would achieve a comparable improvement.