Dean Baker: Higher wages and economic growth are key to fixing Social Security

Social Security is projected to face a funding shortfall in just over a decade. To be clear, this is not as big of a nightmare as is often described. Even if we hit this date and Congress did nothing, the program would still be paying more than 80% of its scheduled benefits.

Social Security could continue to pay the overwhelming majority of scheduled benefits indefinitely. So the idea that today’s young people will end up empty-handed is nonsense. Furthermore, because projected benefits rise each year, today’s young people can expect higher benefits than current retirees, even if nothing is done to the program. The horror stories about Social Security running dry are inventions of politicians who want to cut benefits or privatize the program.

But no one wants to see a 20% cut in benefits in the next decade. This can be avoided. First, it is important to understand that we could, as an economic matter, make up any shortfall out of general revenue.

This is, in effect, what is happening now. The Social Security trust fund is selling off government bonds it purchased in prior decades when it ran a surplus. It is projected to run out of these bonds in more than 10 years. But from an economic standpoint, it makes no difference if the government is paying benefits because it is buying back bonds or it is just paying benefits. It has the same effect on the economy.

But we want to stick to the traditional route of financing Social Security, where the program must rely on its dedicated tax. If we’re going to pay full benefits, we could always raise the payroll tax, but we'll need to remember a few important points when considering this route.

One of the primary reasons Social Security is projected to face a shortfall is the massive upward redistribution of income over the last four decades. In 1982, the last time the program had major changes, only 10% of wage income was above the cap on taxable income (now $160,000).

More than one-third of the projected shortfall would be closed if we could reverse the upward redistribution of wage income over the last four decades. Wage income also has shifted to profits. 

Without this massive shift to the rich at the expense of ordinary workers, instead of facing a risk of cuts of 20%, we would likely be looking at cuts of less than 12%. Also, if we had not seen this upward redistribution over the last four decades, Social Security would hold more government bonds, likely pushing out the date of any projected shortfall beyond the 2030s.

Distribution matters greatly for Social Security’s finances, but growth also matters. When the program was restructured in 1982, it was expected that the strong wage growth during the quarter century post-World War II boom would continue indefinitely. That proved not to be true.

But if we could get back to 2% annual real wage growth -- where wage growth exceeds inflation by 2 percentage points -- it would make fixing the program’s finances in its current structure relatively easy.

It would directly reduce the projected shortfall by close to a third. When wages rise faster than prices, tax revenues increase relative to the benefits paid out.

More rapid wage growth also would facilitate modest increases in taxes. We raised taxes a great deal in prior decades, going from a combined employer-employee tax rate of just 3% at the start of the 1950s to the current 12.4% by 1990.

We know people will never be happy about paying higher taxes. Still, if wages are growing rapidly, they are unlikely to be too upset about giving back a part of their wage gains to support a highly valued program such as Social Security. That, at least, was the experience during the post-World War II boom.

More rapid growth by itself will not “fix” Social Security. But if we get more rapid growth, and the benefits of this growth are widely shared, the projected shortfall will be a problem that is easily solved.