Inside the Social Security Wage Cap Issue

Inside the Social Security Wage Cap Issue

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In a little-noted comment at his town hall meeting at Northern Virginia Community College this week, President Obama called for raising the cap on wages subject to Social Security taxes. It’s an issue worth exploring in depth, since raising the cap would put a big dent in the long-term financial imbalance in the nation’s senior citizen retirement program.

An exploration of the tax cap issue is also important for its social implications. It reveals the economic significance of rising income inequality in the U.S., and how rising inequality has contributed to the long-term government budget crisis that is now dominating the nation’s politics.

The Social Security payroll tax of 6.2 percent is currently levied on wages up to $106,800 a year, which is matched by employers (although most economists view the employer match as wages foregone, not a tax on employers). The cap was set in 1984 and is indexed for inflation.

At first glance, the politics of raising the cap are not much different than eliminating the Bush-era tax cuts on individuals earning over $200,000 a year and households earning over $250,000 a year. While Democrats and the bipartisan presidential fiscal commission see raising the cap as key to any Social Security fix, anti-tax Republicans are steadfastly opposed.

House Budget Committee Chairman Paul Ryan, R-Wis., was asked by a questioner at a town hall meeting in his district this week why he didn’t support higher taxes on the rich, especially given the rise in income inequality in this country. The questioner drew cheers.  “We do tax the top,” Ryan responded. “if you tax them, that is going to hurt job creation.” That answer drew boos.

Some newer members of the House Republican caucus, perhaps reading the polls that show strong support for increasing taxes on well-off Americans, are refusing to draw a line in the sand when it comes to Social Security taxes. At his Illinois town hall meeting freshman Rep. Bob Dold was asked specifically if he would support raising the cut-off for Social Security taxes from its current level to $200,000. “I think it’s certainly something we should take [a look at] with raising the age,” he said. 

A history lesson and a few facts are in order. In 1983, a commission headed by future Federal Reserve Board chairman Alan Greenspan reached a bipartisan compromise that was soon signed by President Ronald Reagan. It saved Social Security for the Greatest Generation just as  those Americans were entering retirement. The deal gradually raised the payroll tax rate, indexed the ceiling on income subject to taxation, and lifted the retirement age to 67 – but not until the middle part of the Baby Boom was scheduled to enter its golden years.

The deal was a spectacular success. Not only did it save Social Security for the World War II generation, by the end of the 1990s Social Security was generating huge surpluses for the government, which continue to this day, even as the income tax cuts enacted in 2001 and 2003 sent  that money back out the door.

A least-noted aspect of that ’83 plan had to do with the level of wages subject to taxation. The cap was designed to hit about 90 percent of all wage and salary income (interest, dividends and capital gains are not subject to the payroll tax). The architects of the compromise calculated the revenue would be sufficient to maintain the system for the next 75 years, or to 2058. That was about the time when the last of the 77 million Baby Boomers would be lowered to a place where they could no longer draw benefits.

But a funny thing happened on the way to the future. Though the cap rose with inflation, the total amount of wages subject to the tax did not. As more and more of the total income pie went to high earners, less and less of total wages wound up being taxed. In fact, by 2008, the total share of wages subject to taxation had fallen from 90 percent  to 83.8 percent of the total. Actuaries at the Social Security Administration, in an email response, said they estimate the total this year will be 83.6 percent of the total.

It’s also important to note that this declining share of taxed income wasn’t caused by more people earning salaries above the cap. According to SSA data, about 6.3 percent of all wage and salary workers in 1983 had earnings above the cap. By 2008, that had fallen to 6.0 percent. In other words, fewer people are earning a bigger share of total income.

I asked the actuarial office what the cap would have to be today to have the tax hit 90 percent of all wages, the benchmark anticipated by Alan Greenspan, Ronald Reagan, the late Sen. Pat Moynihan, D-N.Y.,  and the other architects of the 1983 compromise. “$191,100,” the office replied with its customary precision. “If the increase began in 2012 and was fully phased in by 2017, the estimated trust fund exhaustion year would be 2049.”

According to the last Social Security trustees’ report, the current data for the trust fund’s exhaustion is 2037. Clearly, raising the tax cap won’t solve all Social Security’s 75-year imbalance. But if the nation is committed to the goal of maintaining a stable income floor for all senior citizens, regardless of how well they did during their working years, then raising the cap is a good place to start, especially given the rise in income inequality in the U.S. over the last 30 years.

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spent 25 years as a foreign correspondent, economics writer and investigative business reporter for the Chicago Tribune and other publications. He is the author of the 2004 book, The $800 Million Pill: The Truth Behind the Cost of New Drugs.