If you don’t know this fact about Social Security, join the club. The percentage of earnings for all U.S. workers combined that is subject to the Social Security payroll tax is falling. Growing income inequality is the reason. A recent study identified growing U.S. trade with China as one important factor that is shrinking the share of earnings subject to the payroll tax.
Thirty-five years ago, Social Security taxes were levied on 90 percent of all workers’ earnings. By 2016, this taxable share of earnings had declined to 82.7 percent, according to federal data, and it will continue to drop over the next decade. The payroll tax is 12.4 percent of an individual worker’s earnings, with half deducted from his paycheck and half paid by the employer. But the tax has a cap: once earnings reach $132,900—the cap for 2019—they do not have to pay the tax for the rest of the year. This is where inequality comes in. Since incomes above the cap are growing much faster than regular workers’ incomes, a bigger share of earnings is escaping the cap every year.
China is now the largest source of U.S. imports. The increase in trade volume over several decades has contributed to U.S. income inequality by sharply eroding earnings for workers in the low-wage, low-skill industries that have lost factory jobs to China. But trade with China has actually been good for workers in the top 1 percent—their earnings have increased slightly. Think of the high-tech entrepreneur selling software to a Chinese manufacturer. These are the types of people who stop paying the payroll tax partway through the year, when their earnings exceed the cap.
Notably, the researchers said that if trade with other countries, in addition to China, were included in their analysis, trade’s impact on inequality—and the taxable share—may be even greater. International trade is one of many economic factors eroding the taxable share. Identifying others “is of first-order importance to the Social Security program, to the economy, and to society at large,” the researchers concluded.
You can find this article at Squared Away Blog.