How Social Security could narrow rich-poor gap

When Congress created the Social Security system in 1935, 8 of 11 people reaching retirement age were not just poor - they were indigent. They had almost no income. Some lived on the street, many with their children. They relied heavily on charity to survive.

Those drafting the Social Security bill wanted to redistribute income to these destitute retirees. They succeeded. Today's seniors are relatively flush.

Now, the income gap between the rich and poor in the United States has gotten wider again. A reformed Social Security could help readjust that balance.

It's unclear whether President Bush's plan will do that. But Social Security could be altered to accomplish that goal, says Robert Shiller, an economist at Yale University. He frets that the growing rich-poor gap "is going to fester eventually. It will be a source of resentment."

So he suggests that both the federal income tax and Social Security be indexed so that any growth in this income gap be offset by raising the progressivity of the tax and retirement systems. Here's how it might work:

Between 1979 and 2002, the top 1 percent of the population enjoyed a 111 percent increase in their real income, the Congressional Budget Office reported recently. The top fifth enjoyed a 48 percent gain during the same period while the bottom fifth got only a 5 percent income hike. Following Dr. Shiller's theme, income-tax rates could be raised on high incomes. A special tax-based benefit for the working poor could be enlarged and their Social Security pensions boosted to reflect a higher share of their income while working.

A more modest proposal would be to raise the level of earnings subject to the Social Security tax. Currently, the system taxes only the first $90,000 of income, while a growing number of Americans earn more. In 2001, for example, 15 percent of Social Security contributors made more than the taxable earnings maximum, up from 10 percent in 1983. That trend has happened despite the year-by-year increase in the taxable maximum. That translates into lost funding for Social Security. In 1983, the sum amounted to $305 billion, notes an Economic Policy Institute study. By 2001, that had grown to $775 billion. (To adjust for inflation, both figures are reported in 2004 dollars.)

"More than half of the currently projected shortfall over the 75-year planning horizon is attributable to upward redistribution of wage income since 1983," notes Dean Baker of the Center for Economic and Policy Research, a Washington think tank.

Several reform proposals call for raising the maximum earnings level subject to Social Security taxation. This would improve the system's finances, but not eliminate the financing gap seen by the Social Security Trustees. In their annual report last week, they moved up the projected date of the depletion of the trust fund by one year, from 2042 to 2041. The experts say this shift was driven almost entirely by last year's weaker-than-expected economy.

If their projections hold up, payroll tax revenues in 2042 would cover only 74 percent of promised benefits. In terms of purchasing power, the benefits would still be about 7 percent higher on average than the benefits received by current retirees. Nonetheless, retirees might feel poorer because of the relative prosperity of those still working.

Indirectly, today's Social Security has led to a widening of the rich-poor gap by helping finance Mr. Bush's tax cuts. That's not the system's fault. It's the result of the White House and Congress misusing the system's current surplus. That money is supposed to be socked away for future retirees. Instead, Washington has used it for current spending, including tax cuts that have mostly benefited the well-to-do.

When first proposed, Social Security was billed as insurance, even though it clearly redistributed income, especially to many early recipients of pensions who had paid little or nothing into the system. The reason, one key drafter of the bill told Frank Genovese, an economist emeritus at Babson College in Wellesley, Mass., was that Americans did not believe in redistributing income to the poor. They did believe in insurance. Today, the system does somewhat less to redistribute income and contains real elements of insurance. It provides the disabled and widows and their children with a modest income.

Apparently not many in Washington believe in income redistribution today. Eleven days ago, the Senate voted 55 to 45 to adjust taxes on Social Security benefits in a way that would give those making more than $200,000 a year a 14 percent hike in their after-tax benefits, according to Citizens for Tax Justice. Those making less than $30,000 would get zero.