Lift the Cap on Social Security Taxes

My four-year-old son is fond of asking me, “how goes the work?” Well, if he means working for economic justice, the answer is, “not so well, Sam.” Oh, there are signs of hope. The anti-globalization movement has challenged prerogatives of capital in the international economy. And the Bush administration’s attempt to privatize social security by trumping up a phony crisis seems to have fallen flat.

Mind you, that this mildly redistributive public retirement program should come under attack even after helping to cut poverty rates among the elderly from 35% in 1960 to 10% today speaks volumes about the current political climate.  Social Security is financed by contributions from the wages of working people, not a progressive income tax.  In fact, social security taxes fall far more heavily on the poor and working people than the well-to-do.  That is for several reasons.   Social Security taxes are a fixed 12,4% (actually 6.2% on employees and 6.2% on employers); they are levied only on wage income and not property income; and a cap on wages subject to the tax (and currently set at $90,000) exempts high-income wages.  Even FDR acknowledged that relying on payroll contributions to finance social security was regressive, although he famously argued that with those contributions in place “no damn politician can ever scrap my Social Security program.”

Bush is proving FDR right. So far this year, Bush has made 36 trips to stump for his plan to privatize Social Security, but fewer people support the Bush plan than when he began his campaign. Ironically enough, the only aspect of Social Security reform that has generated widespread support is lifting the cap on wages subject to the tax — a measure that would make Social Security taxes less regressive. In a February Washington Post poll, 81% of the respondents agreed that Americans should pay Social Security taxes on wages over $90,000.

Washington Post/Kaiser Family Foundation/Harvard University Social Security Knowledge Poll, 3-6 Feb. 2005

Removing the cap would just about cover the shortfall in Social Security revenues that would come about if the economy slows to a snail’s pace forecasted by the Social Security Administration (SSA).  Lifting the cap while allowing benefits for high-income taxpayers to increase would cover 93% of the SSA’s projected shortfall in Social Security revenues in the next 75 years.  Removing the cap while keeping benefits for those at the top unchanged would produce a surplus in the system over the next 75 years.

This is hardly a radical idea. AARP, the seniors lobby, endorses raising the cap on wages subject to the payroll tax.  And there is a clear precedent.  A similar cap used to apply to funding Medicare, but a 1993 tax bill removed the cap and now every dollar of wage income is taxed to help to fund the Medicare system.

Finally, the combination of the cap and the unprecedented inequality of the last two decades has shrunk the social security tax base.  Some 90% of wages fell below the cap in 1983.  Today, with the increased concentration of income among the highest-paid, that number is 84.7% (even as the number of workers with earners above the cap has dropped).  To once again cover 90% of all wages, the cap would have to rise to $140,000.  Just that increase would close about one-third of the long-term deficit of the system projected by the SSA.

Monthly Review readers might not see lifting the cap on payroll taxes as class warfare, but the well-to-do sure do.  Just listen to the financial establishment squeal about how removing the cap would soak the rich.  Investment Management chairman Robert Pozen, architect of the benefit cutting proposal endorsed by the Bush administration, deceptively called progressive indexing, warns that “attaining solvency for Social Security in this manner would require “one of the greatest tax increases of all time” and “is so crazy it’s beyond belief.”  The editors of Wall Street Journal agreed in a recent editorial.  And the Heritage Foundation, the conservative think tank, ginned up numbers purporting to show that lifting the cap would impose a “massive 12.4 percentage point tax hike” that would return federal rates to levels not seen since the 1970s.

Just how wet would the rich get if the cap on social security taxes was lifted?  Here are some back of the envelope calculations that say wet, but not soaked by historical standards.

For starters, lifting cap directly affects slightly over 5% of wage-earners, group that has already benefited from three rounds of Bush’s pro-rich tax cuts.  According to the Congressional Budget Office (CBO), effective federal tax rates (how much of their income a taxpayer pays in federal taxes) of the richest 5% of taxpayers fell from 30.1% in 2001 to 25.6% in 2004.

Lifting the wage cap on social security taxes would actually would do little more than reverse those tax giveaways to the wealthy.  The additional tax burden of the richest 5% would be about 5.0 percentage points, even assuming as most economists do that workers end up paying the employers share of the payroll tax (in the form of lower wages) on top their share.   That is because property income not subject to the payroll tax accounts for the majority of the income of the richest 5%. *  Those additional 5.0 percentage points of tax burden would push the effective federal tax rate of the richest 5% to 30.6%, in 2004, somewhat higher than 30.1% rate they faced in 2001 when Bush took office, but still considerably lower than the 31.8% rate they faced in 1979. 

That is hardly soaking the rich.  Also they can afford it.  The best-off 5% of households had an average income of  $281,497 in 2003, some 80% higher than in 1979, even after correcting for inflation.   Still, lifting the cap is a solution to the alleged crisis in Social Security that would actually help to right the economic wrongs of the last few decades.

 

* I calculated 5.0 percentage points from economist Martin Sullivan’s estimates of the additional tax burden from removing the Social Security tax cap.  Using 2001 data, Sullivan found that lifting the cap would add slightly less than $10,000 to the tax burden of the 9.1 million taxpayers with maximum taxable wages.  Those taxpayers had an average income of $160,300, so lifting the cap would boost their effective tax rate by 6.2 percentage points.  But an additional 2.8 million of richest 5% with exclusively property income would continue to pay no payroll taxes.  Assuming their income matches that of the well-to-do wage earners, the effective tax rate for the entire 11.9 million earners in the top 5% would rise just 5.0 percentage points.

Sources:  “Budget Magic and the Social Security Tax Cap,” by Martin A. Sullivan, Tax Notes, 3/14/05; “Social Security: Raising or Eliminating the Taxable Earnings Base,” CRS Report for Congress, 5/2/05;  “Effective Federal Tax Rates Under Current Law, 2001 to 2014,” Congressional Budget Office Paper, August 2004; “Keep the Social Security Wage Cap; Nearly a Million Jobs Hang in the Balance,” by Rea Dederman, Tracy Foertsch, and Kirk Johnson, Center for Data Analysis Report #05-04, The Heritage Foundation, 4/22/05; “A ‘Progressive Solution to Social Security,” by Robert C. Pozen, The Wall Street Journal, 3/15/05; “Social Security Progressives,”  The Wall Street Journal, 3/15/05; and “Wage Gap Figures in Social Security’s Ills,” by Greg Ip, The Wall Street Journal, 4/11/05.


John Miller teaches economics at Wheaton College and is a frequent contributor to Dollars & Sense.  He also writes about sweatshops and the antisweatshop movement and about globalization in Southeast Asia.