Raising someone
else's taxes may seem like a painless solution when a government
program starts running deficits. For instance, in 2017 Social
Security will begin to spend more in benefits than it takes in from
payroll taxes, and some interest groups believe that the ideal
solution is to simply increase taxes on "wealthier"Americans.
Raising payroll
taxes is the wrong solution to Social Security's long term
financing problem, and it is not the way to achieve retirement
security for Americans. The wiser approach is to view Social
Security reform in the context of comprehensive retirement income
reform. That means taking steps to strengthen retirement savings as
well as Social Security and reviewing the tax treatment of
retirement programs and savings plans as well as the structure of
Social Security benefits.
The Wage Cap
A cap on
taxable earnings has existed since the inception of the Social
Security system in 1937.Currently, workers pay Social Security
payroll taxes on only the first $97,500 of their annual income (as
of January 1, 2007; in 2006, workers paid Social Security taxes on
their first $94,200 in wages). This "wage cap"is indexed to the
growth of real wages in the economy and increases every year. The
wage cap serves to limits the amount of Social Security benefits
that a well-off retiree will receive. Even though Bill Gates and
Donald Trump earn millions of dollars a year, for the purpose of
calculating Social Security benefits, they earned just $97,500 in
2007.
The Economic Impact
of Raising the Wage Cap
Raising the amount
of earnings subject to Social Security payroll taxes would do
nothing to address the wider challenge of securing retirement for
working Americans. Moreover, it would have real and damaging
effects on working families and the U.S. economy. Some would
dismiss the negative effects by noting that "only"about 6.5 percent
of taxpayers would be affected, but a large proportion of those
whose taxes would increase earn less than $125,000 annually. While
these workers are not poor, neither are they wealthy. Subjecting
all earnings to Social Security payroll taxes would:
-
Reduce the annual take-home pay of 10.3 million workers by an
average of $5,650 in the first year alone after the cap is removed.
Most of these workers have incomes below $125,000.
-
Raise taxes on 4.0 million workers
over the age of 50-just when they are trying to steer towards
retirement.
-
Raise taxes on 3 million small
business owners.
-
Greatly increase the top effective federal marginal tax rate.
-
Weaken the U.S. economy by reducing the number of job opportunities
and workers'personal savings. By fiscal year 2015, the number
of job opportunities lost would exceed 965,000, and personal
savings would decline by more than $55 billion, in real terms.
- Not
save Social Security. A 2003 Social Security Administration study
showed that eliminating the Social Security wage cap would delay
the program's deficits for only about six years.
Rather than focus on raising the wage cap,
Congress should develop a comprehensive solution to Social
Security's future deficits that examines all aspects of the program
and places a strong emphasis on increasing personal savings across
all income levels. This approach would be the first step towards
placing all entitlement programs on a sound financial footing and
protecting our children and grandchildren from having to deal with
those program's massive deficits.
Stifling Marginal Tax Rates
If Social Security's wage cap were raised,
many workers would immediately find that federal taxes consume over
43 cents of every additional dollar that they earn. While raising
the wage cap is sold with the rhetorical point that "Those who have
benefited from the growth in the economy should be asked to pay a
little more to help secure Social Security,"the fact is that it would mostly hurt the
middle class.
By raising the
wage cap to $140,000, a single worker earning $110,000 would see
his or her marginal tax rate increase from approximately 31 percent
to 43 percent, plus any state or local income tax. A married couple in
which the sole-earner makes $110,000 will see their marginal tax
rate increase from 28 percent to 40 percent. If the other spouse
also works and makes $40,000, the couple would face a marginal tax
rate of 43 percent for both earners. For the highest income
workers, the marginal tax rate would rise from 38.4 percent to
about 53 percent-a level not seen since the 1970s.
A Short Delay of
Massive Deficits
An October 2003 report from the Social
Security Administration (SSA) examined the effects of not just
raising the wage cap, but of eliminating it completely. Under this radical
approach, Bill Gates and Donald Trump would pay Social Security
taxes on every dollar that they earn. They would also receive
benefits on those earnings. The SSA study showed that that
eliminating the payroll tax cap entirely would only delay the start
of Social Security's annual deficits by six years. If completely
eliminating the wage cap only delays Social Security's coming
deficits by six years, just raising it would not solve a
significant part of Social Security's financial
problems.
Who Would Pay More?
Raising the wage cap does not mainly affect
the rich. For every taxpayer with an income of over $500,000
affected by raising the tax cap to $125,000, 24 taxpayers with
lower incomes would pay higher taxes.
In 2004, the majority of taxpayers earning more than $90,000 had
incomes between $90,000 and $150,000. Only a very small number of
the 132 million tax returns filed in 2004 (0.33 percent of
taxpayers) showed income between $500,000 and $1 million, and an
even smaller number (0.18 percent) showed incomes over $1
million.
In addition, raising the wage cap does not
target just executives or the wealthy. Increasing the wage cap
above $97,500 would raise the taxes of 71,214 elementary and middle
school teachers, 97,065 carpenters, 110,908 policemen and
policewomen, 254,992 nurses, 208,562 post-secondary teachers, and
237,000 dentists.
Americans Want
Congress to Fix Social Security
A December 2006
poll showed that Americans want Congress to fix Social Security.
The Rasmussen survey of 1000 likely voters showed that 57 percent
felt that Social Security needed to be fixed, while only 30 percent
wanted the program to be left alone. Other polls show that
Americans want Congress to work on a bipartisan basis to address
key issues such as entitlement reform.
Conclusion
Fixing Social
Security will require bold leadership. Raising the Social Security
wage cap would be damaging and does not reform the program. Some
steps have to be considered to rein in the costs of the program,
such as raising the retirement age, instituting lower promised
benefits for younger workers, and modifying the cost-of-living
adjustment formulas. But a comprehensive approach to fixing Social
Security also requires a comprehensive overhaul of America's system
of retirement financing, including personal savings and the tax
treatment of retirement plans and programs.
Congress should
not try to take the "easy"approach to dealing with Social Security.
While raising Social Security's wage cap would provide more money
to the program and delay the coming annual deficits for a few
years, it would also hurt the economy and the millions of workers
with incomes just about the wage cap. In addition, after such a tax
increase, our children would still be left with a Social Security
program that has promised more in benefits than it can afford to
pay.
Instead, Congress
should consider a comprehensive approach that recognizes America's
changing demographics and creates a sustainable Social Security
system that can afford to pay adequate benefits to those who need
them the most. Most importantly, a comprehensive solution to Social
Security should also enable workers of all income levels to build
personal savings, part of which they could use to enhance their
Social Security benefits or to leave a nest egg to their children.
Such a reform would enable Social Security to provide workers with
the same kind of retirement security that our parents and
grandparents achieved.
David C. John is Senior
Research Fellow in the Thomas A. Roe Institute for Economic Policy
Studies, and Rea S.
Hederman, Jr., is Senior Policy Analyst in the Center for Data
Analysis, at The Heritage Foundation.