A new campaign season has predictably brought a new round of partisan Social Security wars. Even as the system’s trust fund moves within a decade of insolvency—which would trigger an automatic 23 percent reduction in benefits—both Democrats and Republicans are fighting over the title of strongest protector of Social Security benefits.
How do we close a Social Security cash shortfall projected to total $23 trillion over three decades, plus $16 trillion in resulting interest costs? Simple, many say: just eliminate the $168,600 cap on wages subject to Social Security’s 12.4 percent payroll tax.
In 2020, Joe Biden proposed reimposing this tax at wages above $400,000. Leading progressive Social Security proposals by Vermont senator Bernie Sanders and Connecticut representative John Larson would reenact the tax at $250,000 and $400,000, respectively. Political pundits, activists, and commentators have made “eliminate the FICA cap” their catch-all method for achieving long-term Social Security solvency without raising the eligibility age or reforming benefits.
Is ensuring solvency really that easy? Not even close, as my new Manhattan Institute issue brief explains.
The reason Social Security taxes are capped is that Social Security benefits are, too. Because the program is a social-insurance system, retirees can claim that they “earn” their benefits because the benefits are tied to their tax contributions. The Social Security tax reaches its ceiling at $168,600 in wages (adjusted annually for inflation) because any wages earned above that level no longer earn additional benefits. Raising the limit without adjusting benefits accordingly would delink the two, turning Social Security into more of a traditional welfare system.
That said, even if we did do away with the tax ceiling—with no corresponding benefits provided—doing so would not come close to bringing long-term solvency to the program. The Congressional Budget Office projects that Social Security’s annual shortfall will level off at about 1.7 percent of GDP within 15 years. Yet, abolishing the cap would raise 0.9 percent of GDP, closing a little more than half of those shortfalls. In fact, Social Security actuaries calculate that the system would fall back into deficits within just five years.
Thus, the Social Security actuaries note that the leading House progressive proposal, Larson’s, runs deficits every year in perpetuity. The Sanders proposal relies on additional new taxes simply to delay the return to deficits until 2038. There is no magic proposal showing that lifting the limit will avert the need to raise the eligibility age or reform benefits.
One might conclude that, even if ending the cap is not a cure-all, closing a little more than half of Social Security’s shortfall still makes it a logical choice. In reality, such a policy would endanger progressive priorities by diverting nearly all available upper-income tax increases to pay for benefits for baby boomers.
Currently, the marginal tax rate on wages for the highest-earning Americans exceeds 50 percent when including the 37 percent federal income tax rate, 2.9 percent Medicare payroll tax, 0.9 percent additional Medicare tax, and state income taxes that surpass 10 percent in New York and California (where many millionaires reside). Uncapping the payroll tax would add a 12.4 percent tax-rate hike for higher earners, pushing the top marginal rates well above 60 percent. This stands at or near the revenue-maximizing marginal tax rate, according to the consensus among economists, meaning that any extra tax-rate hikes would raise little-to-no additional revenue.
Investment tax rates are also near their revenue-maximizing levels, a wealth tax is almost certainly unconstitutional, and most tax deductions have already been aggressively capped. Nor could even aggressive corporate tax increases generate comparable revenues.
The point is not to sympathize with high earners and their tax burdens. Rather, it is that—with the exception of a few modest tax adjustments—unlimiting the payroll tax to finance Social Security partially would leave no pot of potential tax-the-rich revenues to close Medicare’s much larger funding shortfall (a staggering $77 trillion over three decades). Nor could remaining taxes on wealthy families finance many items on progressives’ wish list, such as climate-change mitigation, free college, student-loan forgiveness, health-care coverage expansions, K–12 education, infrastructure, high-speed rail, childcare, family leave, social safety nets, and housing. Progressives would need to sell (strongly unpopular) middle-class tax hikes to finance the rest of their agenda, as well as to address Medicare’s massive shortfalls and Washington’s escalating baseline deficits in other areas.
Given progressives’ more pressing priorities listed above, directing nearly all remaining tax-the-rich revenues to baby boomer Social Security benefits would be a curious choice. It would be especially surprising given that today’s retirees are the wealthiest age group of Americans in history, with household incomes that have grown four times as fast as the average worker since 1980. Generational equity requires scaling back the unaffordable promises made to higher-earning current and future retirees, rather than maximizing taxes so that most can receive Social Security (and Medicare) benefits well exceeding their lifetime contributions to the systems (adjusted for net present values).
If progressives want to maximize income taxes on the wealthy, surely they can find a better long-term use for those revenues than keeping Social Security out of deficit for five years.
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