On Social Security, Medicare and taxes

Donald Trump never mentioned either program. Harris has a plan. Here are some details on what it might look like and why meaningful tax reform is long overdue.

Among all his fibs, flubs and flustered fulminations, Donald Trump failed to say a word about Social Security or Medicare during last night’s debate. Although he repeatedly promises to protect both programs at his rallies, he never says how he would shore up their finances. Perhaps he has a “concept of a plan,” like he has for replacing the Affordable Care Act.

Kamala Harris took advantage of the opening. “Donald Trump claimed he would allow Medicare to negotiate drug prices. He did not follow through. We did.” That will save Medicare nearly $100 billion by 2031 and far more in the succeeding decade.

She also touted the $35 monthly price cap for diabetics’ insulin and the $2,000 annual limit on prescription drug costs for Medicare beneficiaries. She promised to work to extend the caps to private insurance plans, which requires legislation.

On Social Security, Harris offered what sounded like a Bernie Sanders-esque program for how to strengthen the program’s long-term finances. It is slated to exhaust its trust fund in 2033. She’d close the gap “by ensuring that millionaires and billionaires contribute their fair share of taxes.”

She could have sent a signal to the Bernie bros in the television audience by raising her arms and waving them in circles as she made that pledge. Brooklyn-born Doug Emhoff (the first husband in waiting) could have shown her how during debate prep.

Joking aside, the issue of our unfair tax system and how it contributes to income inequality is crucial to understanding the long-term financing problems faced by both programs, which are still a decade away. Reducing that inequality through higher taxes will be key to preserving their adequacy for future generations.

The roots of the financing crisis

Those old enough to remember the deep recession of the early 1980s can recall the last time Social Security nearly exhausted its trust fund. At the dawn of the conservative era, a commission headed by future Federal Reserve Board chairman Alan Greenspan imposed the traditional conservative approach to ending the immediate crisis: It proposed legislation, eventually passed, that cut benefits. It phased in an increase in the retirement age to 67; it added government employees to its rolls to expand the job base; and it taxed the benefits of high earners. But it also, and most significantly, raised the payroll tax to its current level, which is 12.4% of income evenly split between wage and salary workers and their employers.

Medicare’s trust fund hit its funding wall a decade later, largely driven by rapidly rising hospital costs (the payroll tax only covers Part A or hospital bills). In 1996, a tax set at 0.7% in 1965 when the program began was raised to its current level of 2.9%, again, evenly split between wage earners and employers.

There was one major difference between the two programs’ tax bases. The Medicare payroll tax was applied to 100% of earnings. High-income households even paid a surtax.

The Social Security tax, on the other hand, exempted high-income earners once their salaries reached a certain level, which would be increased each year to reflect inflation. The legislation adopting the Greenspan Commission reforms set the initial cap so it would cover 90% of all wage and salary earnings. Its authors anticipated the annual inflation adjustment would keep it at that level.

Today, the cap is set at $168,600 a year. But it no longer covers 90% of earnings because of rising income inequality. It only covers 81%, according to the Economic Policy Institute.

Two charts released by the Congressional Budget Office today documents why this happened. The top 20% of employees in this country (the top quintile), most of whom earn over the cap, took in a disproportionate share of wage gains over the past four decades. The middle three quintiles saw minor gains. Workers in the poorest quintile saw almost no gains:

Moreover, among the fortunate 20%, the largest gains went to those at the very top — the proverbial 1%:

In other words, virtually all increased earnings for the top 10% or so of wage and salary workers have escaped taxation by the Social Security system over the past four decades.

Bigger pie, smaller slice

There’s a second part to the problem. The share of total national income going to employees in the form of salaries and wages has also declined. While the pie grew, the slice going to workers as wages and salaries shrank. That directly affects both Social Security and Medicare.

For that data, we must turn to the Federal Reserve Board, which each year releases its calculations of the relative share of income for various economic sectors: individuals; corporations; private firms; farmers; and landlords. While there are fluctuations year to year and larger shifts during recessions, the long-term trend is clear: The owners of publicly-traded corporations and privately-held companies are grabbing a larger and larger share of the total income compared to 43 years ago. Both forms of income are exempt from Social Security and Medicare payroll taxes:

To sum up: A smaller and smaller share of national income is going to workers in the form of wages and salaries, while a greater and greater share of total wage and salary income is exempt from the payroll tax because it is going to top earners making more than the Social Security cap. Both trends impact the long-term viability of Social Security and Medicare.

In that last chart, I’ve thrown in the share of corporate earnings paid in corporate income taxes because that, too, is instructive. While Social Security is solely funded by the payroll tax, Medicare depends on the federal government’s general revenue fund to pay for everything the program covers besides hospital care: physician visits; rehab in nursing homes; prescription drugs; hospice; and more.

By dividing the share of corporate profits by the share of those profits paid in income taxes, we can see that corporations paid over 33% of their income in taxes in 1980 to help pay for those and other government programs. By last year, that ratio had fallen to less than 18%.

When populism was real

Is there a solution? Undoing the rise in income inequality that has marked the past four decades will require major shifts public policy whose full impact won’t be felt for another generation. Only the Great Depression allowed a president and Democratically-controlled Congress to pass labor laws, tax policies and public infrastructure programs that helped create what economists call the Great Compression — the period between the end of World War II and the middle of the 1970s when the difference in salaries between blue and white collar workers was small and the pay of top executives was only 21 times that of the average worker — not the 344 times we see today.

Securing Social Security and Medicare for the next generation can’t wait for those structural reforms. To shore up program finances, President Biden has proposed extending the payroll tax to cover household earnings over $400,000 a year. Harris has endorsed that plan.

Sen. Sanders would lower than level to $250,000 (a much smaller donut hole between that and the current $168,600 cap). He would also expand the Social Security tax base to include interest and dividends. That addresses another contributor to the rise in income inequality. Another line on the FRB’s national income distribution charts shows that the share of corporate profits paid to stockholders as dividends rose from slightly over half in 1980 to nearly 70% in 2023.

Meaningful tax reform will depend on Democrats winning the White House and Congress. But who knows, maybe giving J.D. Vance (R-OH) a good spanking in the election will remind him when he returns to the Senate that he was against further tax breaks for corporations before he was for them.