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Obama's Second Term

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Don't Raise or Eliminate the Cap

April 18th 2013

US Capital Day

Under Roosevelt's original design for Social Security, high earners wouldn't even have participated. The eventual legislation included the rich, but with a contribution cap to distinguish Social Security from "the dole."

As a Social Security Administration report put it, "The upper limit on the tax was designed to assure that no one contributed directly more than the value of the protection he received." It also meant that lower earners must pay for their benefits, which the administration says is "one of the basic principles of the Social Security program and is largely responsible for its widespread public acceptance and support."

But by eliminating the cap, a person earning $225,000 would pay roughly four times more in taxes than he'll receive in benefits. A growing resemblance to a welfare plan would be inescapable. Today's payroll tax ceiling isn't unusually low. Currently, about 84 percent of all wages are taxed, almost precisely the average since 1935. While coverage has fallen from 90 percent since the mid-1980s, research points to health care as a major culprit.

When employers' health outlays rise they reduce wages for employees, with middle class workers hit the most. The solution isn't to tax the rich more, it's to address health care costs. And while Canada sets its pension tax ceiling at the average wage - and the U.K. at 1.15 times and Germany and Japan at 1.5 times the average - Social Security's tax ceiling is 2.9 times the average wage, helping give the U.S. the most progressive tax code in the developed world.

Eliminating the tax cap would be a huge tax increase. The top federal tax rate on earned income today is 45 percent. Adding state income taxes boosts it to around 50 percent. Eliminating the tax max effectively raises the top tax rate by around 12 percentage points. And that's before we've done anything to fix Medicare and Medicaid.

Moreover, liberal economists Emmanuel Saez and Jeffrey Liebman concluded that, because of income shifting and behavioral responses, net collections from eliminating the cap would be less than 60 percent of what static projections claim.

Even at that level of revenue, eliminating the tax cap would lead to large near-term Social Security surpluses - which would be spent rather than saved -- while doing far less to boost the system's long-term prospects. Raising the cap would sap support for Social Security and hurt the economy, while failing to put the budget on a sustainable track.

Andrew G. Biggs is a resident scholar at the American Enterprise Institute, from where this article is adapted.


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