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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