CRS Updates Report on Taxable Earnings Base for Social Security

Social Security taxes are levied on covered earnings up to a maximum level set each year. In 2007, this maximum -- or what is referred to as the taxable earnings base -- is $97,500. The taxable earnings base serves as both a cap on contributions and a cap on benefits. As a contribution base, it establishes the maximum amount of each worker's earnings that is subject to the payroll tax. As a benefit base, it establishes the maximum amount of earnings used to calculate benefits.

Since 1982, the Social Security taxable earnings base has risen at the same rate as average wages in the economy. However, due to increasing inequality, the percentage of covered earnings that are taxable has decreased from 90% in 1982 to 85% in 2004. The percentage of covered earnings that is taxable is projected to decline to about 83% for 2014 and later. Since the cap was indexed to the average growth in wages, the share of the population below the cap has remained relatively stable at roughly 94%. Of the 8.5 million Americans with earnings above the base, roughly 80% are men and only 9% had any earnings from self-employment income. New Jersey has the highest share of the population above the maximum (10%) and South Dakota has the lowest share (2%).

CRS used the Dynasim statistical model to estimate the potential impact of eliminating the taxable wage base on future benefits and taxes. If the base were removed in 2013, CRS estimates that by 2035, 21% of beneficiaries would have paid some additional payroll taxes over the course of their lifetimes. However, the average change in taxes and benefits would be small. Looking only at individuals who would pay any additional taxes over the course of their lifetimes, at the median, total lifetime tax payments would rise by 3% and benefits would increase by 2% relative to current law. In general, those in the highest income groups would have the largest changes in both tax payments and in benefits relative to current law.

Raising or eliminating the cap on wages that are subject to taxes could reduce the long-range deficit in the Social Security Trust Funds. For example, if the maximum taxable earnings amount had been raised in 2005 from $90,000 to $150,000 -- roughly the level needed to cover 90% of all earnings -- it would have eliminated roughly 40% of the long-range shortfall in Social Security. If all earnings were subject to the payroll tax, but the base was retained for benefit calculations, the Social Security Trust Funds would remain solvent for the next 75 years. However, having different bases for contributions and benefits would weaken the traditional link between the taxes workers pay into the system and the benefits they receive.

Raising or eliminating the taxable earnings base would also raise significant revenue. The Joint Committee on Taxation estimates that $221 billion would be raised over the five year budget window 2008-2012 if the base were to cover 90% of total earnings.

This report will be updated as legislative activity warrants.

 Contents

Origin and History of the Taxable Earnings Base

In 1935, the designers of Social Security -- President Franklin Roosevelt's Committee on Economic Security -- did not recommend a maximum level of taxable earnings in its plan, and the draft bill that President Roosevelt sent to the Hill did not include one. The bill emphasized who was to be covered by the system, not how much wages should be taxed. Being in the midst of the Depression, the Administration's attention was on the large number of aged people living in poverty. Its goal in proposing a Social Security program was to complement public assistance measures (Old-Age Assistance) in its plan. The plan offered immediate cash aid to the aged poor and created an earnings-replacement system intended to lessen the need for welfare benefits in the long run. It was recognized that the new system would not be sufficient to provide full income in retirement, but would provide a "core" benefit as a floor of protection against poverty. Not concerned about high-income retirees, the Administration's proposal exempted non-manual workers earning $250 or more a month from coverage (i.e., $3,000 on an annual basis). Manual workers were to be covered regardless of their earnings, but few had earnings above this level.

It was the Social Security bill reported by the House Ways and Means Committee that clearly established a maximum taxable amount, which it set at $3,000 per year.² In addition, the committee dropped the exemption for non-manual workers with high earnings. The committee's report and floor statements made at the time give no clear record as to the reasoning for the taxable limit, but concerns about tax equity and attaining as much program coverage of the workforce as possible were suggested as factors for rejecting the high-earner exemption. Not covering them meant that they would not pay the tax where lower wage earners would, and coverage would be erratic for workers whose earnings fluctuated above and below the $250 monthly threshold.

Although tax policy concerns were raised in later years, with a higher base preferred by those seeking a more proportional tax system, there was little if any serious attention given to eliminating the base entirely. In the late 1940s and early 1950s and to a lesser extent later on, the major arguments were over the base's size and how it affected the development of Social Security. A larger base meant that more earnings would be credited to a person's Social Security record and would lead to higher benefits (since benefits are based on a worker's earnings). Proponents argued that the base needed to be raised to reflect wage or price growth so that the benefits of moderate and well-to-do recipients would not erode over time (thereby preserving their support for the system). Critics argued that this would increase benefits for people who could save on their own while making saving by private means more difficult. In 1972, as a means of financing cost-of-living adjustments for Social Security recipients, procedures were enacted that increased the base automatically to reflect the growth in average wages. In 1977, the base was raised beyond what resulted from the automatic increase provision (by $7,500 over three years) as a means of raising revenue to help shore up the program's ailing financial condition. These ad hoc adjustments were intended to achieve a base under which 90% of all covered payroll would be subject to tax.

Medicare was enacted in 1965 with the hospital insurance (HI) portion of the program financed with payroll taxes. The HI tax was first levied in 1966 at a rate of 0.35% (on employee and employer, each) and the maximum taxable amount was set at the same level as Social Security's.³ The HI rate was subsequently raised periodically (reaching its current level of 1.45% in 1986) to meet the financing needs of the program. However, its base continued to be the same as Social Security's through 1990. Then, to reduce federal budget deficits, the Omnibus Budget Reconciliation Act of 1990 (P.L. 101-518) raised the HI base to $125,000. The HI base then rose automatically to $135,000 over the next two years. In 1993, as part of his plan to reduce budget deficits, President Clinton proposed that the HI base be eliminated entirely. As part of the Omnibus Budget Reconciliation Act of 1993 (P.L. 103-66) the HI base was removed, raising an estimated $29 billion in revenues over the FY1994-FY1998 period. As there is no maximum taxable earnings amount in Medicare, Medicare financing will not be discussed further in this report.

In 2007, an estimated 163 million workers paid Federal Insurance Contributions Act (FICA) taxes and Self-Employment Contributions Act (SECA) taxes on their wages and net self-employment income.^4,5 Both employers and employees contribute earnings at the FICA rate and SECA taxes are paid by the self-employed. Both taxes have three components: Old Age and Survivors Insurance (OASI), Disability Insurance (DI), and the Hospital Insurance (HI) part of Medicare. The OASDI tax is levied on earnings up to $97,500 in 2007. The HI tax is levied on all earnings.

The taxable earnings base limits the amount of wages or self-employment income used to calculate contributions to Social Security. Unlike income taxes, workers who have earnings over the limit, whether they earn $100,000 or $100 million, pay the same dollar amount in Social Security payroll taxes. Under the 2007 limit of $97,500, the maximum amount a wage and salary worker contributes to Social Security is $6,045 (his or her employer contribute an equal amount) while a self-employed individual contributes a maximum of $12,090.⁶

The taxable earnings base also limits the annual amount of earnings that are used in benefit calculations and thus sets a ceiling on the amount Social Security pays in benefits. For example, the maximum amount of earnings in 2007 used to calculate a worker's benefit is $97,500, regardless of whether the worker earned above that amount. If an individual earned at or above the earnings base for his or her entire career⁷ and retired in 2007 at the full retirement age, his or her annual benefit would be $25,440 ($2,120 per month), the maximum benefit payable under current law. However, very few Americans receive the maximum benefit as it is extremely rare to have had such consistently high earnings over a lifetime.

    2007 Social Security and Medicare Tax Rates and Maximum Taxable

The portion of Social Security covered earnings that are subject to the payroll tax has fluctuated over time (Figure 1). When the program began in 1937, taxable earnings represented 92% of covered earnings (Table A-1). By 1965, this ratio had dropped to its low of 71%. Prior to 1972, the taxable earnings base was updated periodically by Congress, which contributed to its dramatic fluctuations in the 1950s and 1960s. Since 1972, the base has been indexed to the increase in wages in the economy which has reduced the volatility somewhat. As described earlier, to raise revenue Congress raised the taxable earnings base in the 1977 amendments to the Social Security Act to a level that would cover 90% of aggregate earnings by 1982.

Since the 1980s, the share of covered workers below the taxable earnings base has remained relatively stable at roughly 94%. However, the share of covered earnings that are taxed has fallen from 90% of all earnings in 1982 to 85% in 2004. The large declines in the late 1990s were mainly due to the fact that salaries for top earners grew faster than the pay of workers below the cap.⁸

 

Figure 1. Share of Earnings and Workers Above the Taxable Earnings

 

Base, 1950-2004

 

 

 

The Taxable Earnings Base by State

In 2004, nearly 6% of workers had earnings above the taxable base of $87,900.⁹ However, focusing on the nationwide average hides the diversity among the states and the District of Columbia. The share of the population above the base in 2004 ranges from a high in the District of Columbia, where 12% of covered workers earn above the base, to a low in South Dakota, where 2% of workers earn this amount (Table A-2). The states with the lowest share of workers over the base are South Dakota, North Dakota, Mississippi, Montana, and Arkansas. Those with the highest share of workers over the base are the District of Columbia, New Jersey, Connecticut, Maryland, and Massachusetts.

The Taxable Earnings Base by Employment Status and Gender

According to statistics from the Social Security Administration, a small share of workers earn above the taxable earnings base each year. In 2003, 6% of workers (8.5 million individuals) earned more than the taxable earnings base (Table A-3).¹⁰ Most of the individuals earning above the base were men (6.7 million individuals or roughly 80% of the total). In 2003, 8% of all male workers and 3% of all female workers had earnings above the maximum. Most individuals earning above the base were wage and salary workers (roughly 90% of the total). Only 1 in 10 individuals who earned above the base were self-employed. Roughly 5% of all wage and salary workers (7.9 million individuals) and 5% of all self-employed workers (765,000 individuals) had earnings above the base in that year.

The Future of the Taxable Earnings Base

The taxable wage base is increased annually by the average growth in wages, so the share of the population below the cap is expected to remain relatively stable over time. However, due to increasing earnings inequality, the share of payroll that is taxed is expected to decline even further. Under the intermediate assumptions of the 2006 Trustees Report, the percentage of covered earnings that is taxable is projected to decline to about 83% for 2015. However, the Trustees Report assumes the levels will remain stable thereafter.

Projections of the Share of the Population Earning Above the Taxable Wage Base Over Their Lifetime

Workers' earnings rise and fall during their careers, so any analysis of the population that earns above the taxable wage base in a given year is limited in that it may miss individuals who were above the base in previous years or will have earnings above the base in the future. To address this issue, CRS used the Dynasim microsimulation model to estimate the share of individuals in the future who will ever have earned above the current-law taxable wage base over the course of their lifetimes.¹¹

 

Figure 2. Share of the Population with Earnings Above the Taxable

 

Wage Base Over Their Lifetime

 

 

 

In 2003, 6% of workers earned more than the taxable earnings base.¹² The Dynasim model projects this share will remain relatively constant over time. While a small share of workers are projected to earn above the taxable earnings base in a given year, the model estimates that roughly one in five individuals would earn above the maximum at some point in their lifetimes (Figure 2). The model projects that 12% of workers would earn above the earnings base for between one and five years over the course of their working lives. Very few individuals sustain the high earnings for long periods in their careers. The model estimates that only 5% of workers would earn above the taxable wage base for more than five years.¹³

Very few individuals have earnings higher than a level of taxable earnings that would cover 90% of aggregate earnings (the level Congress attempted to achieve when it last addressed Social Security's finances). The Dynasim model projects that roughly 1% of workers have earnings above a 90% limit each year. In other words, due to high levels of earnings inequality, roughly 1% of the population earn 10% of all the earnings.¹⁴ Looking over the course of an individual's lifetime, the model projects that less than 4% of the population would ever earn above the 90% base and nearly all of those who do would earn above the base for less than five years (Figure 2).

Rather than eliminate the taxable wage base, policymakers could set it to cover a constant share of aggregate earnings. As described previously, the portion of Social Security covered earnings subject to the payroll tax has fluctuated since its inception. Rising inequality -- primarily increases in the earnings of the highest paid individuals -- has led to a decline in the share of U.S. earnings that is taxed. The proportion of earnings that is taxed is projected to continue to fall. Maintaining a consistent tax base would increase revenue and help to improve the system's solvency. Some have proposed raising the taxable earnings base to consistently tax 90% of aggregate U.S. earnings -- restoring it to roughly the level in 1982 when Congress last addressed Social Security's finances. The Social Security Administration and the Joint Committee on Tax have also used this benchmark to analyze the impact of raising the base on the Social Security trust funds and the budget.

The following sections examine the impact of raising or eliminating the taxable wage base on individuals, the Social Security trust funds, on federal revenue, and on workers' and employers' behavior.

Impact on Individuals' Lifetime Payroll Taxes and Social Security Benefits if the Taxable Wage Base were Eliminated

To estimate how much individuals' taxes and benefits would rise if the wage base were eliminated, CRS has used the Dynasim microsimulation model to look at Social Security beneficiaries in the year 2035. The estimates assume the taxable wage base would be completely eliminated starting in 2013 for calculating both the payroll taxes and future Social Security benefits. The following sections detail the impact of eliminating the base on beneficiaries based on their income and gender.¹⁶

Aggregate Changes. If the base were removed, the majority of beneficiaries would pay no additional taxes compared with current law, as fewer than 8% of workers are projected to earn above the taxable wage base each year. Examining the impact on individuals receiving Social Security benefits in 2035, roughly one in five beneficiaries (21%) would have paid any additional taxes over their lifetimes compared with current law (Figure 3). For most of these affected individuals, the increase would be moderate. Roughly 16% of all beneficiaries would see their lifetime tax payments increase by less than 10%. However, 3% of all beneficiaries would have their tax payments increase by 10% to 19%, and 2% would have tax increases of 20% or more.

To maintain the traditional link between contribution and benefits, policymakers could choose to calculate benefits based on a worker's total earnings, including those above the taxable wage base. Under this option, some beneficiaries would receive higher Social Security benefits. CRS estimates that 23% of beneficiaries in 2035 would have higher benefits than under current law. This share of beneficiaries who receive higher benefits is greater than the share of individuals who pay higher taxes because some low earners receive benefits based on their spouses' higher earnings. Most of the affected beneficiaries (20%) would see their benefits increase by less than 10% relative to current law. Only 3% of beneficiaries would see their benefits increase by 10% or more.

While 21% of beneficiaries in 2035 would pay some additional payroll taxes over the course of their lifetimes if the base were removed, the average change in taxes and benefits would be small. Looking only at individuals who would pay higher taxes over the course of their lifetimes, at the median, total lifetime tax payments would rise by 3% and benefits would increase by 2% relative to current law.

 

Figure 3. Share of Beneficiaries in 2035 with Tax and Benefit

 

Increases Compared with Current Law If the Taxable Earnings Base Is

 

Eliminated, by Level of Increase

 

 

 

Note: Lifetime taxes include both individual and employer OASDI contributions or self-employment contributions throughout the individual's entire career.

Changes by Income Group. The impact of eliminating the taxable wage base on payroll taxes paid varies significantly by income group.¹⁷ The overwhelming majority (98%) of beneficiaries in 2035 in the lowest income quintile would pay no additional taxes over their lifetime (Figure 4). Few in this group would receive benefit increases if the cap were removed. Under this proposal only 3% of beneficiaries in the lowest income category would receive benefit increases, and the increase would be for less than 10%.

The story is different for higher income beneficiaries. Roughly one-half of those in the highest income quintile are estimated to have had tax increases over their lifetimes relative to current law. While 35% of beneficiaries in the top quintile would see their lifetime taxes rise by less than 10%, some (7%) would see their taxes rise between 10% and 19% and some (6%) would see their taxes rise 20% or more. Beneficiaries in the highest income groups would also see the largest change in their benefits if the taxable wage base were removed. One-half of beneficiaries in the top fifth of the income distribution in 2035 would have an increase in benefits relative to current law. In this highest quintile, 42% would have benefit increases of less than 10%, some (5%) would have benefit increases of 10%-19% and a few (3%) would have benefit increases of 20% or more.

 

Figure 4. Share of Beneficiaries in 2035 with Higher Payroll Taxes

 

or Benefits Compared with Current Law If the Taxable Earnings Base Is

 

Eliminated, by Highest and Lowest Quintile

 

 

 

Changes by Gender. Since the majority of workers who earn above the taxable wage base in a given year are men (Table A-3 and described above), men would be more likely to pay higher payroll taxes than women if the taxable wage base were eliminated. Among men who receive benefits in 2035, more than one in four would pay higher payroll taxes over the course of their lifetimes (Figure 5). Twenty percent of male beneficiaries would have a tax increase of less than 10%, but 7% would see their lifetime tax contributions increase by more than 10%. If the taxable earnings base was removed, one in four men would receive higher benefits. The majority of the men affected (22% of all male beneficiaries) would see a small increase in benefits, but 3% of all men would have benefits increase by more than 10%. In contrast, only 15% of women who receive benefits in 2035 would have paid any additional payroll taxes over the course of their lives. Of these women, only 2% would have an increase of over 10%. Since many women receive benefits based on their spouses' earnings, the share of women who would see a rise in benefits is higher than the share that would pay additional taxes. Although the benefits of one in five female beneficiaries in 2035 would rise, for most it would be a small increase of less than 10%.

 

Figure 5. Share of Male and Female Beneficiaries in 2035 with

 

Higher Payroll Taxes or Benefits Compared with Current Law If the

 

Taxable Earnings Base Is Eliminated, by Gender

 

 

 

Impact on the Social Security Trust Funds

Under the assumptions of the 2005 Trustees Report, the actuaries at the Social Security Administration calculate that it would take an immediate increase in combined payroll taxes of 1.92% of taxable payroll (from 12.40% to 14.32%) to achieve solvency over the next 75 years.¹⁸ Without this increase or other changes to the system, the 2005 Trustees Report projected that the OASDI Trust Funds would be exhausted in 2041. The actuaries at SSA have estimated the impact on the Trust Funds of three options to change the benefit and contribution base which are described below.

   Table 1. Impact on the Social Security Trust Funds of Raising or

Option 2: Cover All Earnings and Pay Higher Benefits. If the earnings base was completely eliminated for both employers and employees so that all earnings were taxed, 95% of the projected financial shortfall in the Social Security program would be eliminated. To achieve solvency for the full 75-year projection period under this option, the total payroll tax rate would have to be raised by an additional 0.1 percentage points (from 12.4% to 12.5%) or other policy changes would have to be made to cover the shortfall.

Under this scenario high earners would pay higher taxes but also receive higher benefits. However, the net benefit to the Trust Funds is positive as $5 in additional revenue would provide only $1 in additional benefits (on average over their 75-year valuation period). Annual Social Security benefit payments would be much higher than today's maximum of $25,440. A worker who paid taxes on earnings of $400,000 each year would get a benefit of approximately $6,000 a month or $72,000 a year -- a replacement rate of 18% -- while someone with lifetime earnings of $1 million a year would get a monthly Social Security benefit of approximately $13,500 a month or $162,000 a year -- a replacement rate of 16.2%.^21,22

Option 3: Cover All Earnings and Pay No Additional Benefits. Finally, if the base was completely eliminated for both employers and employees so that all earnings were taxed, but those earnings did not count toward benefits, solvency would be restored to Social Security. The increased revenue would eliminate 115% of the projected shortfall and the program would have a surplus of 0.29% of wages. Under this scenario, the payroll tax rate could be immediately lowered from 12.40% to 12.11% and the system would remain solvent for the next 75 years. However, the traditional link between the level of wages that are taxed and the level of wages that count toward benefits would be broken.

Impact on Federal Revenue

Raising the taxable earnings base would lead to an increase in total federal revenues. The Joint Committee on Taxation has estimated that raising the wage base to 90% of earnings, to $186,000 in 2008, would generate $221 billion in additional revenue over the five-year budget window of 2008-2012 (Table 2).^23,24 Over 10 years, the policy would generate more than $524 billion. Rasing the payroll tax base to cover an additional 1%-2% of income (above the 90% level) would generate $32-$64 billion more over five years and $80-$158 billion more over 10 years.

    Table 2. Revenue Impact of Raising the Social Security Taxable

The reaction of high-earning workers and their employers to raising or removing the taxable earnings base is unknown and was not taken into consideration in the above estimates of the distributional, trust fund, and revenue impacts.

Workers who earn more than the cap would have a reduced incentive to work as their after-tax earnings will fall.²⁵ However, whether these individuals would significantly reduce the amount they work is a matter of debate.²⁶ Each worker would face a decision between the reduced earnings and the additional leisure time, based on the worker's individual preferences. Workers who have earnings above the current base would also have an incentive to change the form of their compensation (e.g., from earnings to fringe benefits) to avoid paying additional payroll taxes.²⁷

The impact of raising the base on employers of high-income earners is also unknown. Employers contribute 6.2% of workers' wages up to the taxable wage base toward Social Security. If employers are unable to pass along the higher tax costs to workers in the form of reduced earnings, their overall labor costs will increase. Employers may react by raising prices to consumers, reducing other non-wage forms of compensation such as health benefits or pensions, or reducing the number of workers.

A number of proposals to raise or eliminate the taxable wage base have been made in recent sessions of Congress, although none have received legislative action. In the 105th Congress, Senator Moynihan proposed raising the base to $97,500 by 2003 ($15,600 more than it was projected to be under current law) as part of a package of changes to restore Social Security's long-range solvency (S. 1792). He again included an increase in the base in a solvency package he introduced in the 106th Congress (S. 21). Similar base hikes were contained in other solvency bills in the 106th introduced by Senators Gregg and Breaux, et al. (S. 1383 and S. 2774) and by Representative Nadler (H.R. 1043). In the 107th Congress, H.R. 2771, introduced by Representatives Kolbe and Stenholm, held the base at 86% of total payroll. In the 108th Congress, two bills raised the wage base. A bill by Kolbe and Stenholm (H.R. 3821) gradually raised the base to $133,200 in 2008 and then held the base equal to 87% of total payroll thereafter. H.R. 5179, sponsored by Representative Obey, brought the percentage of covered earnings subject to the Social Security payroll tax up to 90% by increasing the rate of growth in the Social Security taxable wage base by 2 percentage points above average wage growth for years 2006 through 2036.

Two bills were introduced in the 109th Congress to change the taxable wage base. H.R. 440, introduced by Representative Kolbe and Representative Boyd, gradually raised the base to $142,500 in 2010 and then indexed it to 87% of total payroll thereafter. A bill by Representative Wexler (H.R. 2472) required workers and employers to each contribute 3% of earnings above the taxable wage base while self-employed individuals contribute 6% of earnings above the taxable wage base. Under the Wexler bill, earnings above the taxable wage base taxed at the 3% rate would not be credited for benefit computation purposes.

Legislation in the 110th Congress

To date, no bills have been introduced that would change the taxable wage base.

Arguments For

The major critique about the Social Security base is that it creates a regressive tax structure. Workers earning less than the base have a greater proportion of earnings taxed than workers whose earnings exceed it. In 2007, someone with annual earnings of $30,000 pays $1,860 in Social Security taxes, or 6.2% of his or her earnings (ignoring the employer share of the tax). However, because the tax is levied on only the first $97,500 in earnings, someone earning $200,000 a year pays $6,045 or 3% of his or her earnings.

Supporters of changing the wage base point out that only 5% of workers have earnings above the base. However, due to rising income inequality, the amount of their earnings that escapes taxation has risen from 12% to 15% since 1991, and is projected to continue to rise through 2014. They therefore contend that the current tax structure favors a small group of the more well-off workers in society.

They also point out that the overall employee tax rate rose from 6.13% in 1980 to 7.65% in 1990 (counting the Medicare portion) -- or by 25% -- and assert that this increase is one of the main reasons for a disproportionate rise in the aggregate federal tax burden on lower and middle-income people over that decade.²⁸ They further maintain that for most workers, Social Security and Medicare taxes (counting the employer share, which they view as foregone wages) are now greater than their income taxes.

Supporters argue that subjecting a larger percentage of earnings to the payroll tax would also adjust for the higher life expectancies of high earners.²⁹ On average, people with more education and higher earnings live longer than those with lower earnings and less education and this difference has been growing over time. The impact on the Social Security program is that these individuals receive benefits for more years over their lifetimes making the system less progressive.³⁰ They claim that raising the taxable wage base would make a reasonable adjustment for the faster-than-average life expectancy gains among high earners.

Thus, supporters of changing the base argue that raising or eliminating the base not only would be more fair, but also that Social Security's projected long-range financing problems could be substantially alleviated or, alternatively, that the payroll tax rate could be reduced without causing a loss of revenue to the system. It is estimated that almost $100 billion in revenue to the Social Security program would be generated annually by taxing all earnings, and if such revenues were not used to lower the tax rate, they would reduce the government's outstanding debt and eliminate about 95% of Social Security's long-range deficit.

Within the group that support changing the current base, there is disagreement regarding how high the base should be raised or if other changes should be made to tax income above the base. Several proposals would not eliminate the base entirely but raise it to cover 90% of taxable wages, restoring the level that was set in the 1977 amendments to the Social Security Act. Others have claimed that increasing the base to 90% would be a large tax increase for those who earn between the current base and the new level, but would have little impact on the share of taxes paid by individuals with the highest earnings.³¹ Other options would be to remove the cap completely over the base, but lower the tax rate on those higher earnings³² or tax employers and employees at different rates above the current base. Others have called upon broadening the sources of income that are taxed beyond earnings.³³ Proponents of these ideas argue that they would close a significant portion of Social Security's longrange deficit without subjecting upper-middle income individuals to sizeable increases in their marginal tax rates.

Arguments Against

Those who support keeping the base as it is point out that while the structure of the payroll tax may be regressive, it is offset by the progressive calculation of benefits.

They further maintain that its critics fail to take into account the effect of other tax and transfer programs targeted to low-earners. They point out that mitigating the Social Security tax bite was part of the motivation for creating the earned income tax credit (EITC), which provides an income tax credit on earnings up to $38,348 in 2006 for married workers with two or more children (up to $14,120 for married workers without children). They also point out that low-income families receive a greater share of government transfer payments that are not subject to Social Security payroll taxes. They argue that the combination of these factors mitigates the flat-rate nature of the tax at lower earnings levels, and that for most other workers the tax is proportional (because it is flat-rate). It is only at the upper end of the income spectrum that it takes on a regressive appearance.

Critics also argue that raising the cap will serve as a disincentive to work and could serve as a drain on the economy.³⁴ Because additional work effort would generate less after-tax income, supporters claim that workers faced with this higher marginal rate would either reduce their hours or avoid the tax by changing the form of their compensation.

From another perspective, some -- who might otherwise espouse progressive taxation -- support raising the base but not eliminating it. Having a cap makes Social Security seem less like general purpose taxation. They argue that the system needs support from people of all earnings levels, and that the larger benefits that high earners would receive would represent a poor return for the higher taxes they would pay. Moreover, regardless of the money's worth issue, some question the wisdom of paying large benefits to well-to-do people. They argue that the purpose of the program is to provide a floor of protection for retirement, not large benefits for those who can save on their own. They contend that eliminating the base would raise public cynicism about a publicly financed system that pays enormous benefits to people who already are well off.

² The maximum for a worker was to be $3,000 per year per employer, so that, under the original legislation enacted in 1935, someone could have paid tax on more than $3,000 in earnings per year (and received benefits from all such wages) if they worked for more than one employer.

³ The same maximum taxable amount was set for the self-employed when they were covered in 1951 and for the Disability Insurance (DI) portion of the tax when it was first levied in 1957.

⁴ Social Security Administration.

⁵ Some workers (approximately 4%) are exempt from Social Security payroll taxes and are therefore not "covered" by Social Security. From this point forward, all references to earnings are "covered" earnings and workers are "covered" workers. For a listing of workers who are exempt from Social Security taxes see CRS Report 94-28, Social Security and Medicare Taxes and Premiums: Fact Sheet, by Dawn Nuschler.

⁶ $97,500 x 6.2% = $6,045 and $97,500 x 12.4% = $12,090.

⁷ The Social Security benefit formula calculates benefits based on a worker's highest 35 years of earnings.

⁸ At least some of this decline and subsequent increase in the ratio after 2000 is believed to be due to stock option activity surrounding the stock market bubble in 2000 and is not likely to recur. (SSA, 2005 OASDI Trustees Report.)

⁹ Note that the calculations in Tables A-1, A-2 and A-3 differ slightly due to differences in data.

¹⁰ Social Security Administration, Annual Statistical Supplement 2005, [http://www.ssa.gov/policy/docs/statcomps/supplement/2005/ 4b.html#table4.b1]. ( Hereafter referred to as SSA Statistical Supplement, 2005.)

¹¹ The Urban Institute's Dynamic Simulation of Income Model (Dynasim) is a computer model that uses survey data to project earnings, demographic changes, retirement income, and Social Security benefits through the year 2050. For more information about the model, how it works, and how to interpret results, see CRS Report RL33840, Options to Address Social Security Solvency and Their Impact on Beneficiaries: Results from the Dynasim Microsimulation Model, by Laura Haltzel, et. al.

¹² SSA Statistical Supplement, 2005.

¹³ The share of the population affected by this policy is influenced by the way the Dynasim model projects an individual's earnings. There is a significant amount of year-to-year variation in the projection of each individual's earnings.

¹⁴ The Dynasim model projections are consistent with current data on wage inequality. In 2004, the top 1% of earners were paid 11% of aggregate earnings (source: CRS analysis of the March 2005 Current Population Survey).

¹⁵ There is precedent for this proposal. When the hospital insurance (HI) tax was levied in 1966 the maximum taxable amount was set the same as for Social Security. As part of the Omnibus Budget Reconciliation Act of 1993 (P.L. 103-66), the HI base was removed.

¹⁶ CRS estimates of the impact of this and other reform proposals, including raising the base to cover 90% of taxable earnings, are also available based on beneficiaries' socioeconomic status (including ethnicity, education, and marital status). (CRS Report RL33841, Options to Address Social Security Solvency and Their Impact on Beneficiaries: Results from the Dynasim Microsimulation Model -- Detailed Distributional Tables, by Laura Haltzel, et. al.)

¹⁷ Note that the income groups are defined in 2035 using family income after an individual claims disability, retirement, survivor, or spousal benefits. Thus, some low income beneficiaries are affected by the policy if they earned above the taxable wage base at any point in their careers.

¹⁸ The projections in this section were done using the assumptions of the 2005 Trustees Report to match the estimates in Table 4 which are the most recent estimates available for these options.

¹⁹ Social Security Administration, Estimated Financial Effects of "A Nonpartisan Approach to Reforming Social Security -- A Proposal Developed by Jeffrey Liebman, Maya MacGuineas and Andrew Samwick" -- INFORMATION, Memorandum, dated November 17, 2005, [http://www.ssa.gov/OACT/solvency/Liebman_20051117.pdf]

²⁰ Social Security Administration, Estimated OASDI Long-Range Financial Effects of Several Provisions Requested by the Social Security Advisory Board, Memorandum, dated August 10, 2005, [http://www.ssab.gov/financing/2004_update.pdf].

²¹ Calculations are for 2005 from Reno and Lavery, Options to Balance Social Security Funds, February 2005.

²² Benefits this high would be extremely rare as very few individuals earn above the taxable wage base for their entire career.

²³ Congressional Budget Office, Budget Options, Revenue Option 39: Increase the Upper Limit for Earnings Subject to the Social Security Payroll Tax, February 2007 [http://www.cbo.gov].

²⁴ Note that the estimates by the actuaries at the Social Security Administration (SSA) and the Joint Committee on Taxation (JCT) differ slightly due to different assumptions. SSA assumes the maximum wage base will be adjusted each year to keep taxable wages at a constant percent of wages while the JCT assumes it will be a one-time increase with adjustments only for inflation thereafter. JCT estimates also account for the effects on all sources of revenue including changes to income taxes and Medicare taxes.

²⁵ The response by high earners may depend on whether the wage base is raised slightly or completely eliminated.

²⁶ For a more detailed discussion of this debate, see CRS Report RL33944, Increasing the Social Security Payroll Tax Base: Options and Effects on Tax Burdens, by Thomas L. Hungerford.

²⁷ See Martin Sullivan, "Budget Magic and the Social Security Tax Cap," Tax Notes, March 14, 2005.

²⁸ See CRS Report RL32693, Distribution of the Tax Burden Across Individuals: An Overview, by Jane G. Gravelle and Maxim Shvedov.

²⁹ See Peter A. Diamond and Peter R. Orzag, Saving Social Security: A Balanced Approach, Brookings Institution, 2004.

³⁰ The Social Security benefit formula is thought to be progressive in that the monthly benefits of low-wage earners replace a greater proportion of their earnings than do the monthly benefits of high-wage earners.

³¹ For a study of how the effective tax rates paid by different income groups would change under such a proposal, see CRS Report RL33949, Increasing the Social Security Payroll Tax Base: Options and Effects on Tax Burdens, by Thomas L. Hungerford.

³² Robert C. Posen, "PIN Money," Wall Street Journal, January 9, 2007.

³³ Citizens for Tax Justice, An Analysis of Eliminating the Cap on Earnings Subject to the Social Security Tax and Related Issues, November 30, 2006, at [http://www.ctj.org/pdf/socialsecuritytaxearningscapnov2006.pdf].

³⁴ See D. Mark Wilson, Removing the Social Security's Tax Cap on Wages Would Do More Harm Than Good, The Heritage Foundation, October 18, 2001.