Raising or eliminating the cap on wages subject to taxes could reduce the long-range deficit in the Social Security trust funds, says the Congressional Research Service (CRS), in a report it issued on Sept. 2 that outlines proposals that would use those approaches.
The report, “Social Security: Raising or Eliminating the Taxable Earnings Base
,” is an update to its report on Social Security.
The CRS cites the 2020 annual report
by the Social Security Trustees on the trust funds’ status, which said that their projections for the long-term financial status of OASDI trust funds are the same as those issued in 2019. Those projections say that absent changes to the law, the Old Age and Survivors Insurance and Disability Insurance (OASDI) trust funds would be depleted in 2035
Raising or even removing the taxable earnings base could increase the solvency of the Social Security system, suggests the CRS; they add the caveat that the full impact of any change would depend on whether the wages above the maximum would also be counted toward benefits.
For instance, the report says, raising or eliminating the taxable earnings base while maintaining the current benefit structure would result in higher monthly Social Security payments for those who earned more than the current taxable earnings base during their careers. These higher payments would increase program outlays; however, the CRS says, they “would be more than offset” by increased tax revenues. “Although the solvency impact would be improved to a greater degree if the cap on taxes were eliminated and the cap on benefits were retained, the traditional link between contributions and benefits would be broken,” says the CRS.
The CRS cites Social Security actuaries’ suggestions for increasing contributions, which include:
- eliminating the taxable earnings base immediately or in a future year;
- raising the taxable earnings base so that a much higher percentage of earnings is subject to the payroll tax;
- taxing earnings above the current taxable earnings base at a lower payroll tax rate; or
- taxing earnings above a certain threshold that is greater than the current-law taxable maximum at the current payroll tax rate.
To accommodate changes to the payroll tax, they further suggest that benefits associated with earnings above the current taxable earnings base can be:
- credited the same as the earnings below the current taxable earnings base;
- still counted toward benefits, but at a reduced rate; or
- not credited at all.
Increasing the Taxable Earnings Base to Cover 90% of Earnings
Proposals to increase the taxable earnings base to cover 90% of earnings generally follow two approaches:
- Phase in the increase over the next 10 years.
- Increase the taxable earnings base by an additional 2% on top of year-to-year indexing, until taxable earnings cover 90% of covered earnings.
Changing the Benefit Formula
Changing the Social Security benefit formula would be a way to maintain the link between contributions and benefits, but limit the benefits for high earners, the report suggests. This proposal, the CRS says, would eliminate 66% of the projected shortfall.
To yield these results, either (1) the payroll tax rate would need to be increased from 12.40% to 13.49% or (2) other policy changes would have to be made for the system to be solvent for the next 75 years.
Taxes on Earnings Above a Certain Threshold Until the Taxable Earnings Base Is Eliminated
Several proposals suggest applying the current payroll tax rate on earnings above a certain threshold and taxing all earnings once the current-law taxable maximum exceeds that threshold. These proposals would eliminate 60%-70% of the projected financial shortfall.
To yield these results, either (1) the payroll tax rate would need to be increased by 0.98% to 1.29% or (2) other policy changes would have to be made for the system to be solvent for the next 75 years.
Eliminating the Earnings Base
The report says that the Social Security Administration’s Office of the Chief Actuary analyzed several proposals that involve eliminating the taxable earnings base immediately, so that all earnings are taxed; these proposals differ based on how benefits are calculated to take into account earnings above the current taxable earnings base.
In all of those proposals, says the CRS, the trust fund depletion date is pushed back by at least 30 years. If no credits to benefits are provided for earnings above the current taxable earnings base—that is, earnings above the current taxable earnings base do not count toward benefits—the trust fund becomes depleted a little less than a decade before the long-range 75-year solvency target. The increased revenue would eliminate 73% of the projected shortfall.
To yield these results, either (1) the payroll tax rate would need to be increased from 12.40% to 13.25% or (2) other policy changes would have to be made for the system to be solvent for the next 75 years.
If all wages counted toward benefits as they are now, the trust fund would be depleted in 2056, and 55% of the projected financial shortfall in the Social Security program would be eliminated, says the report.
For there to be solvency for the whole 75-year period, this option would require either (1) an increase of 1.43 percentage points in total payroll tax rate (from 12.40% to 13.83%) or (2) other policy changes.
Pro and Con
The CRS outlines arguments for and against raising or eliminating the Social Security taxable earnings base.
Arguments For. Supporters of changing the taxable earnings base contend that:
- it creates a regressive tax structure above maximum taxable earnings;
- subjecting a larger percentage of earnings to the payroll tax; and
- would also adjust for high earners’ higher life expectancies and their fast gains in life expectancy.
Arguments Against. The CRS says that supporters of keeping the Social Security taxable earnings base unchanged argue that:
- even though payroll taxes are not imposed on earnings above a certain level, Social Security benefits still are progressive based on how they are calculated;
- those who want to change the base do not take into account the effect of other tax and transfer programs targeted to low earners; and
- raising the base will serve as a disincentive to work by encouraging those faced with lower marginal rewards for work either to reduce their hours or change the form of their compensation.
Arguments Against Elimination. The CRS notes that other arguments against eliminating the Social Security taxable earnings base include:
- Maintaining a base makes Social Security seem less like ordinary income taxation.
- High earners would receive more benefits but also would pay higher payroll taxes, rendering those larger benefits a poor return for the higher taxes.
- Some question paying higher benefits to those who with high incomes, and argue that the purpose of Social Security is to provide a floor of protection for retirement, not large benefits for people who can save on their own.
The CRS report also looks at the potential impacts of various proposals to bolster OASDI finances.
Workers’ and Employers’ Behavior. The CRS anticipates varied reactions among certain workers and employers to raising the taxable earnings base.
||Reaction of Their Employer
|Earning more than the taxable maximum
- Reduced incentive to work
- Incentive to change the form of compensation (e.g., from earnings to fringe benefits) to avoid additional payroll taxes
- Raising prices
- Reducing nonwage forms of compensation, such as health benefits or pensions
- Cutting staff size
Federal Revenue. Raising the taxable earnings base would increase total federal revenue, says the report. The Joint Committee on Taxation and the Congressional Budget Office, the CRS says, estimated that raising the wage base to cover 90% of earnings to $285,000 in 2019 would generate $350.2 billion in additional revenue over the five-year budget window (2019-2023) and $804.9 billion over the 10-year window (2019-2028). Outlays would amount to almost $20 billion over the 10-year period.