Social Security faces a severe financing shortfall within the next 15 years and possibly before the end of this decade, depending on the long-term impact of the COVID-19 pandemic and its effect on the economy, jobs and payroll taxes. The result could be a 21% across-the-board cut in the benefits of all Social Security recipients unless Congress acts before then to shore up the program’s long-term finances.
One of the many proposed funding solutions is to increase the amount of wages subject to payroll taxes. In 2020, the maximum taxable earnings base is $137,700, which serves as a cap on both contributions and benefits.
As a contributions base, it establishes the maximum amount of a worker’s earnings that is subject to payroll taxes. As a benefit base, it establishes the maximum amount of earnings used to calculate benefits.
Of the 7.65% payroll tax rate paid by both workers and their employers, the 6.2% portion that funds Social Security is levied on wages up to the taxable maximum of $137,700 in 2020. The remaining 1.45% portion that funds the Medicare Hospital Insurance trust fund applies to all wages, even those above the taxable wage maximum. Self-employed individuals pay both the employer and employee share for a combined self-employment tax rate of 15.3%.
Since 1982, the Social Security earnings base has risen at the same rate as average wages in the economy, so the share of the population below the cap has remained relatively stable at roughly 94%. But because of the increasing gap between the salaries of top earners and the taxable maximum wage base, the percentage of covered earnings that is taxed has decreased from 90% in 1982 to 83% in 2018.
Th approximately 10 million workers who have earnings above the limit pay the same dollar amount in Social Security payroll taxes whether they earn $200,000 or $2 million a year. Under the 2020 limit of $137,700, the maximum amount a wage and salary a worker contributes directly to Social Security is $8,537, with the worker’s employer contributing an equal amount. A self-employed individual contributes a maximum of $17,075.
Raising or eliminating the cap on wages that are subject to taxes could reduce the long-range deficit in the Social Security trust funds. But the full impact of the policy change would depend on whether wages above the maximum would also be counted toward benefits.
The Social Security Administration’s Office of the Chief Actuary estimates that phasing in an increase in the taxable maximum for both contributions and benefit base to cover 90% of covered earnings over the next decade would eliminate roughly 20% of the long-range shortfall in Social Security, according to a new, well-documented report from the Congressional Research Service.
Raising or removing the taxable earnings base while maintaining the current benefit structure would lead to higher monthly Social Security checks in the future for individuals who earned more than the current taxable earnings base.
The impact on trust fund solvency would be more significant if the cap on taxes were eliminated but the cap on benefits were retained. Under one such scenario, the Social Security trust funds would remain solvent for more than 40 years. However, the traditional link between contributions and benefits would be broken. That could weaken the political clout that the program has enjoyed for more than 85 years largely as a result of its near-universal coverage and status as an earned benefit.
Supporters of raising or eliminating the taxable wage base argue that workers earning less than the base have a greater proportion of their earnings taxed than workers whose earnings exceed it. They also argue that subjecting a higher percentage of earnings to the payroll tax would adjust for the higher life expectancy of higher earners, who tend to receive benefits for more years over their longer lifetimes than lower-income workers.
Opponents of changing the wage base note that low earners benefit from other tax programs, such as the Earned Income Tax Credit, and receive a greater share of government transfer payments that are not subject to payroll taxes. Critics also argue that raising or eliminating the cap will serve as a disincentive to work and could create a drain on the economy.
The taxable wage base is just one of the complicated and controversial issues that Congress must consider when it finally tackles critically needed Social Security reform. Although the COVID-19 pandemic and the upcoming presidential elections have been sucking up most of the political oxygen, lawmakers can’t ignore this critical issue forever. If they delay much longer, millions of American retirees may be left gasping for air.
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