One possible way to
improve the solvency of the Social Security system is to boost the amount of
earnings subject to the payroll tax
A reader recently
asked me about various Social Security reform proposals
that would raise the maximum taxable wage base as a way to improve the
long-term solvency of the Social Security trust funds.
The combined
reserves of the Old Age, Survivor and Disability (OASDI) trust funds are
expected to be depleted in 2035 unless Congress acts before then, leaving the
program with only enough income from payroll taxes to pay 80% of promised
benefits, according to the latest annual report
from the Social Security and Medicare Board of Trustees.
The primary source
of financing for Social Security is payroll taxes imposed by the Federal
Insurance Contribution Act. The Social Security portion of FICA imposes a tax
rate on wages, split evenly between employers and employees. Self-employed
individuals pay both portions of the tax.
The maximum taxable
wage base establishes the maximum amount of a worker's earnings that is subject
to the payroll tax. It also establishes the maximum amount of earnings used to
calculate benefits.
"Would Social
Security benefits increase for those who pay those extra taxes?" the
reader asked. It depends on whether congressional reformers merely raise the
amount of wages subject to payroll taxes or if they also tweak the benefit
formula.
In 2019, workers
and employers each pay 7.65% on up to the first $132,900 of wages. The maximum
taxable amount increases to $137,700 in 2020.
Of that tax, 6.2%
funds Social Security and the remaining 1.45% — which applies to all earning,
even those above the taxable maximum — goes to fund Medicare. In addition,
individuals with earned income of more than $200,000 ($250,000 for married
couples filing jointly) pay an additional 0.9% in Medicare taxes that are not
included in the above percentages.
Since 1982, the
Social Security taxable earnings base has risen at the same rate as average
wages in the economy. Because the cap is indexed to the average growth in
wages, the share of the population below the cap has remained relatively stable
at about 94%.
However, as a
result of increasing earnings inequality, the percentage of aggregate covered
earnings that is taxable has decreased from 90% in 1982 to 83% in 2017,
according to a recent report from the
Congressional Research Service.
Unlike income
taxes, workers who have earnings above the limit, whether they earn $200,000 or
$2 million, pay the same dollar amount in Social Security payroll taxes. The
maximum amount a wage earner contributes to Social Security in 2019 is $8,240,
while a self-employed individual contributes a maximum of $16,480.
The Social Security
benefit formula calculates benefits based on a worker's highest 35 years of
earnings. Monthly benefits are reduced if a worker claims benefits before full
retirement age and are increased if the worker postpones benefits beyond FRA.
If a worker earned
at or above the earnings base for his or her entire career, which is rare, and
retired in 2019 at FRA, he or she would receive the maximum benefit of $2,861
per month ($34,332 per year). Those who postpone benefits beyond FRA earn
additional delayed retirement credits of 8% per year up until age 70.
"Raising or
eliminating the cap on wages that are subject to taxes could reduce the
long-range deficit in the Social security trust funds," the CRS report
said. "For example, phasing in an increase in the taxable maximum to cover
90% of covered earnings over the next decade would eliminate roughly 30% of the
long-range shortfall in Social Security," the report said.
"If the cap
was eliminated completely and all earning were subject to the payroll tax, but
the current law base was retained for benefit calculations, the Social Security
trust funds would remain solvent for over 60 years," the CRS report said.
A separate report from the
University of Pennsylvania's Penn Wharton Budget Model estimates
the effects of raising the Social Security taxable maximum to $300,000 starting
on Jan. 1, 2021. This is a theoretical exercise, not an actual policy proposal.
"We estimate a
policy option that would raise the taxable maximum from the projected level of
$140,900 in 2021 to $300,000 would raise about $1.2 trillion over the period
from 2021 to 2030," the Penn Wharton researchers wrote. As under current
law, this new taxable maximum would increase over time with aggregate wage
growth, but there would be no corresponding increase in Social Security
benefits for workers who paid more taxes during their lifetimes.
"The cost of
this policy would fall largely on the upper-middle class and richest
Americans," the researchers wrote. "After-tax income for those in the
95th to 99th percentage would fall by 1.3%, experiencing the greatest change of
any income group," boosting their payroll taxes by about $3,830 per year
on average. Workers with earnings under the current taxable maximum would not
be affected by this policy.
Congress must
eventually tackle Social Security reform. A key trend to watch will be whether
lawmakers are willing to weaken the traditional link between the taxes that
workers pay into the system and the benefits they receive in exchange for
shoring up the long-term finances of the Social Security program.
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