Problem Statement
An aging population and shrinking workforce, whose payroll tax contributions fund Social Security, mean that under current law, the Social Security Trust Fund will be depleted by 2035, triggering an automatic cut in benefits for beneficiaries of the program. What can Congress do to progressively prevent cuts in benefits to the United States’ most vulnerable populations who rely on Social Security payments?
Background
Social Security, the common name for Old-Age, Survivors and Disability Insurance (OASDI), was created in 1935, as part of the New Deal1. At the time Old-Age benefits were payable beginning at age 65. Life expectancy, however, was only 66 years for 20-year-olds in 1935, meaning the population was younger than today’s population. Workers also had more working years ahead of them, even with the Great Depression and high unemployment, and had fewer projected years to collect benefits when they reached the age threshold for benefits1. As part of the creation of Social Security in the 1930s, President Franklin Roosevelt wanted earmarked taxes to fund the program, to protect it from cuts in the future. Thus, the Social Security Trust Fund was created, into which payroll taxes entered and were used to buy Treasuries to earn interest and from which benefits were paid out. Social Security is funded by a 6.2% employee payroll tax and a 6.2% employer side payroll tax. It is generally believed by economists that the entire 12.4% tax burden falls on workers, as employers pass their tax burden onto workers in the form of reduced wages2. The payroll rate of 12.4% is subject to a cap3. Therefore, income above a certain threshold is no longer taxed by Social Security’s payroll tax. This cap has changed over time. When payroll taxes were first collected by Social Security in 1937 (benefits began being paid to beneficiaries in 1940), 92% of all wages in the United States were taxable under Social Security’s payroll tax. When Social Security encountered a funding crisis in the 1980s, the cap was set to cover 90% of all wages in the United States and grow with average wage growth. Wage growth, however, has not been uniform across earners since the 1983 reform1. Higher earning households have seen wages grow much faster than middle and lower earning households, distorting the average and reducing the percentage of total wages subject to the payroll tax. Consequently, due to rising inequality in the United States, the percent of total wages taxable by Social Security’s payroll tax has decreased to 83% (the cap in 2018 was $128,400). In the very long run since the inception of Social Security, wages covered by the payroll tax have decreased from a starting point of 92%, decreased as a percentage of total wages (71% of wages were covered at one point) until 1983. In 1983 the rate was set back up to 90% of all wages due to an immediate crisis, and has decreased to 83% today because no major reforms have taken place since the crisis in the 1980s and rising wage inequality1,3.
While the Congressional Budget Office (CBO) generally makes projections that cover 10 years, the Social Security Administration makes 75-year projections about the financial stability of the program1. Currently, the Social Security Trust Fund, if it continues to operate under current law with no changes, will be depleted in 20354. When the fund is depleted, benefits are automatically cut so that the earmarked payroll tax revenue matches outlays to beneficiaries1,4. The shortfall is projected to immediately cut benefits for beneficiaries to 79% of their former level, decreasing further over time4. This cut would be devastating for Social Security beneficiaries. In 2016 it is estimated that Social Security kept 26 million vulnerable Americans out of poverty, 17 million of these being aged 65 and older5. Social Security is a type of insurance program that is difficult to obtain in a private market and is therefore an ideal area a policy intervention for the government to provide financial security to its residents1.
Landscape
Social Security payments are structured to be progressive in nature, meaning that the lower the recipient’s income, the higher the payment from Social Security1. Because Social Security is funded by payroll taxes, the funding mechanism is regressive in nature1,2. Putting a hard cap on the wages subject to the payroll tax means that higher earning households pay substantially less as a share of their income in payroll taxes than lower earning households. Even when including the .9% Additional Medicare Tax on wages exceeding $200,000 ($250,000 for married couples) associated the Affordable Care Act, these higher earners pay more than 4.5% less of their income in payroll taxes2. This is a huge tax cut at high income levels. This is more than twice as large as the tax cut to the highest tax brackets (single filer making more than $500,000/married couple making over $600,000) found in the Tax Cuts and Jobs Act6.
Americans generally feel that their tax rate is fair while people making more and corporations pay too little in taxes (Exhibits 1, 2, 4-6)7. They also feel that lower income Americans pay more in taxes than they should (Exhibit 3)7. Since the payroll tax is capped at a certain income threshold and is regressive in nature, there exists the political circumstance in the attitudes of voters’ perceptions of tax rates to make progressive changes to Social Security to maintain its solvency. Social Security is extremely popular, with 66% of voters saying they would be more likely to support a political candidate who would strengthen the program8.
Determining whether Social Security is progressive or not would seem to compare the progressive payments based on income with the regressive tax that funds the program. The progressive payments are more progressive than the tax is regressive so Social Security would seem to be a progressive policy on net. However, it has been established that lifetime income is strongly correlated with longer life spans1,9. This reduces how progressive the program is because more higher income individuals collect payments by reaching the retirement age. They also collect more payments by living past the retirement age longer and therefore collect more, smaller payments over a longer period of time (Exhibit 7)1. This correlation makes Social Security less progressive and closer to a neutral policy. Further, although life expectancy has grown for the United States, like wage growth, the growth has not been equal across income levels9. Richer Americans have seen their average life expectancy grow much faster than the poorest Americans, even though they were starting with a longer beginning life expectancy (Exhibit 8)9.
Income tax burdens in the United States are historically low, even when compared to eras of exceptional economic growth. For instance, in 1952 the lowest tax bracket was 22.2% and the highest was 92%, a tax rate so high that no employers were paying employees’ salaries in that high bracket because the take home pay was so low (the resulting effective tax rate was much lower than 92%)10. There were also 24 brackets, resulting in an extremely complex tax code10. Nevertheless, GDP growth in 1951 was 8.0%, a number not seen in generations11. Higher taxes on the wealthy do not preclude strong economic growth and help inequality, particularly when the taxes collected are being used to finance payments being paid progressively to those in lower income brackets, like Social Security. Social Security taxes are also much easier to collect than payroll taxes, making changes easier to implement.
Options
There are different approaches to solving the crisis Social Security face. Given the popularity for an expansion of Social Security, voters’ willingness to see higher taxes on the wealthy, and a historically low cap on wages subject to payroll taxes, raising the cap on wages subject to the payroll tax is an obvious choice for a policy intervention. The ideal policy would raise the revenue needed to prolong the solvency of Social Security, reduce the inequality present in Social Security, and not need to be revisited frequently.
Option 1 comes from the CBO’s 2018 report on options to reduce the deficit. The cap would set back from 83% of wages to 90% again, growing with average wage growth3. This would raise a net of $704 billion dollars from 2021-2028 (Exhibit 9)3. These estimates in net revenue account for reduced compensation related to the increase in the wages that employer side of the payroll tax would cover12. 90% of wages would equal $296,000 in 2020, up from $128,4003. The CBO estimates that the solvency of Social Security would be increased by 5 years3. Enacting this option would create the same long-term equity problem as the 1983 reforms, as wage growth continues to be uneven.
Option 2 also comes from the CBO: taxing all wages above $250,000 and not indexing the amount in any way, leaving a gap in the current cap and the $250,000 threshold, which would eventually be filled by inflation3. This option raises much more revenue but is much more punitive of a tax. The CBO estimates that by 2037, 100% of wages would be subject to the tax. This policy would raise $1.0857 trillion dollars by 2028 and extend the life of Social Security until 2044 (Exhibit 10)3. The policy would discourage work, as people would earn less per extra dollar paid and hour worked at certain income thresholds.
Option 3 is option 1 from the CBO but indexing the growth of the cap to average wage growth, projected to average about 3.5% in the 2020s, with an additional .5% added to the growth of the cap, making it a 4% increase annual. This would account for the inequalities present in wage growth in recent years and raise more revenue. Adding the index would increase revenue into the trust fund, extending the life of the program further and reduce the need to revisit this aspect of the program in the future if wage growth inequalities continue. This option raises more revenue than option 1 and makes using Social Security as a political hostage less likely in the future (Exhibit 11). The growth in taxable wages does not seem substantial at first look, but neglecting to put a similar policy in place during the last major Social Security debate has helped deplete the trust fund decades later. The amount of inequality taxed over 8 years can be found in Exhibit 12.
Recommendation
Option 3 best achieves the goals the best for altering the payroll tax wage cap for Social Security. Although not included in this memo, the additional tax revenue from the inequality tax may be earmarked to boost benefits for the lowest earning recipients of Social Security to further combat rising inequality. Option 2 discourages work, even though it raises more revenue. Option 1 simply resets the clock on the past 40 years and does not help reduce the growing inequality in modern society in future years. Any of these three options would need to be paired with other alterations to Social Security, such as changes in benefits and other tax changes. These other necessary actions are not discussed here. Option 3 makes the tax code more progressive and is in line with recommendations from the CBO and the Bipartisan Policy Center for extending the life of Social Security. It is clear that further action beyond changing the payroll tax is needed, as the more punitive and work discouraging option, option 2, only extends the life of the program into the 2040s, before many people working now will see benefits. Other changes such as raising the payroll tax rate, recalculating cost of living numbers and raising the retirement age will all have to be considered to put Social Security on a sustainable path.
Exhibits
Exhibit 17
| Opinions on own Taxes | Too high | About Right |
| 2020 | 46% | 48% |
Exhibit 27
| Opinions on fairness of own tax rate | Fair | Not fair |
| 2020 | 59% | 39% |
Exhibit 37
| Opinions on others’ tax rates | Low income | ||
| Fair | Too high | Too little | |
| 2019 | 33% | 48% | 17% |
Exhibit 47
| Opinions on others’ tax rates | Middle class | ||
| Fair | Too high | Too little | |
| 2019 | 48% | 43% | 7% |
Exhibit 57
| Opinions on others’ tax rates | Upper Class | ||
| Fair | Too high | Too little | |
| 2019 | 27% | 9% | 62% |
Exhibit 67
| Opinions on others’ tax rates | Corporations | ||
| Fair | Too high | Too little | |
| 2019 | 23% | 6% | 69% |
Exhibit 79
| Income group | Life expectancy in 2014 |
| Richest Men | 87.3 years |
| Poorest Men | 72.7 years |
| Richest Women | 88.9 years |
| Poorest Women | 78.8 years |
Exhibit 89
| Income group | Growth in life expectancy 2001-2014 |
| Richest Men | 2.34 years |
| Poorest Men | .32 years |
| Richest Women | 2.91 years |
| Poorest Women | .04 years |
Exhibit 93
| Option 1: Raise wages covered to 90% | |||||||||
| 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | Total | |
| Net decrease in the deficit in billions of dollars | 81 | 83.4 | 84.9 | 86.8 | 89 | 90.9 | 92.6 | 95.2 | 703.8 |
Exhibit 103
| Option 2: Tax wages above $250,000 | |||||||||
| 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | Total | |
| Net decrease in the deficit in billions of dollars | 111.6 | 117.6 | 123.9 | 131 | 138.7 | 146 | 153.5 | 163.4 | 1085.7 |
Exhibit 113, 12, Author’s calculations
| Option 1: Raise wages covered to 90% and index by .5% | |||||||||
| 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | Total | |
| Net decrease in the deficit in billions of dollars | 81 | 83.4 | 84.9 | 86.8 | 89 | 90.9 | 92.6 | 95.2 | 703.8 |
Exhibit 12Author’s calculations
| 2021 | 2022 | 2023 | 2024 | |
| Income Inequality Revenue | $673,634,525 | $677,074,198 | $689,251,791 | $704,676,743 |
| 2025 | 2026 | 2027 | 2028 | |
| Income Inequality Revenue | $722,537,213 | $737,962,165 | $751,763,438 | $772,871,266 |
| Total Inequality Revenue | $5,729,771,338 |
References
- Gale, W. G. (2018). Fiscal Therapy. New York, NY: Oxford University Press.
- The Center on Budget and Policy Priorities. (2020, April). Policy Basics: Federal Payroll Taxes. Retrieved from https://www.cbpp.org/research/federal-tax/policy-basics-federal-payroll-taxes
- Congressional Budget Office, Options for Reducing the Deficit: 2019 to 2028 (2018). Retrieved from https://www.cbo.gov/system/files/2019-06/54667-budgetoptions-2.pdf
- Social Security Administration. (2020, April). Social Security’s Long-Term Financial Outlook. Retrieved May 5, 2020, from https://www.ssa.gov/policy/social-security-long-term-financial-outlook.html
- Fox, L. (2017, September). The Supplemental Poverty Measure: 2016. Retrieved from https://www.census.gov/content/dam/Census/library/publications/2017/demo/p60-261.pdf
- Tax Policy Center. (2018). How did the Tax Cuts and Jobs Act change personal taxes? Retrieved from https://www.taxpolicycenter.org/briefing-book/how-did-tax-cuts-and-jobs-act-change-personal-taxes
- Gallup. (2020). Taxes. Retrieved from https://news.gallup.com/poll/1714/taxes.aspx
- Benesch, L. (2018, March 16). New Polling on Social Security, Medicare, and Prescription Drug Prices. Retrieved from https://socialsecurityworks.org/2018/03/16/new-polling-social-security/
- Chetty, R., Stepner, M., Abraham, S., Lin, S., Scuderi, B., Turner, N., … Cutler, D. (2016). The Association Between Income and Life Expectancy in the United States, 2001-2014. Jama, 315(16), 1750–1766. doi: 10.1001/jama.2016.4226
- Tax Brackets. (2020). Federal Income Tax Brackets (Tax Year 1952). Retrieved from https://www.tax-brackets.org/federaltaxtable/1953
- Country Economy. (n.d.). United States (USA) GDP – Gross Domestic Product. Retrieved from https://countryeconomy.com/gdp/usa?year=1954
- Congressional Budget Office. (2019). The Budget and Economic Outlook: 2020 to 2030. Retrieved from https://www.cbo.gov/system/files/2020-01/56020-CBO-Outlook.pdf