CHICAGO (Reuters) - It’s Tax Day, and a small number of wealthy Americans have something to celebrate: They are done paying Social Security taxes for the year.
The payroll tax that funds Social Security is levied only on a certain amount of income. This year it’s capped at $117,000. That means most wage earners will pay 6.2 percent of every dime they earn in 2014, but high earners will stop paying after passing the cap. If you’re among the 318,400 workers who will earn $407,000 or more this year, you’re done paying Social Security taxes today, according to the Center for Economic and Policy Research (CEPR), a progressive think tank. Some 2 million taxpayers will be done on June 15, and 3.7 million on September 15.
This means some people face a much higher Social Security tax rate than others. Under the Federal Insurance Contributions Act (FICA), the Social Security tax is applied as a straight percentage of income; it’s levied at a rate of 12.4 percent of income (minus employer-provided healthcare and life insurance), split evenly between employees and employers, up to the cap. If you earn anything up to $117,000 per year, your rate is 6.2 percent of total income. But if you earn $250,000, it’s just 2.9 percent.
That’s not how the system was designed. The clear intent of Congress, expressed in 1977 revisions to the Social Security Act of 1935, is that 90 percent of all payroll covered by the Social Security system should be taxed. Under the law, the cap is adjusted annually to reflect wage inflation, but the flattening of wages for most Americans - and runaway income at the top - means that more income “escapes” the cap.
Currently, we’re collecting on just 82 percent of the wage base. Weak wage growth and rising earnings inequality are key culprits, along with the rising value of fringe benefits such as health insurance. They are driving the projected long-term shortfalls in the combined retirement and disability trust fund, which is expected to be exhausted in 2033 absent any reforms. Social Security would then be able to pay 77 percent of scheduled benefits.
That has put the cap at the center of the debate over Social Security reform. Raising or eliminating the cap on income subject to tax has been suggested often as a way to improve the program’s long-term funding gap. New payroll tax revenue could close the gap by anywhere from 28 percent to 90 percent, depending on the cap’s height and to what extent the new revenue is used to boost payouts to high-income households.
Elimination of the cap also figures in a broader discussion aimed at addressing the looming retirement security crisis among middle- and lower-income households. Enhancing Social Security looks like the best solution to that problem.
Under the “Strengthening Social Security Act of 2013” introduced by Senators Tom Harkin (D-Iowa) and Mark Begich (D-Alaska), the taxable maximum would be phased out gradually by 2018. The plan would also increase annual cost-of-living adjustments and change benefit formulas to increase benefits for all seniors by about $70 monthly. Along with boosting benefits, the plan would extend the trust fund’s solvency by 16 years, according to the Social Security actuaries.
Who would be affected by a change in the cap? A CEPR analysis of 2011 Census Bureau data found that eliminating the cap would affect the pocketbooks of the top 5.2 percent of wage earners; lifting it to $250,000 would hit 1.3 percent. The affected workers would be 97.5 percent male and 98 percent white.
But would the wealthy get anything back in return for paying higher Social Security taxes? High-income households already get a lower rate of return on their FICA contributions in Social Security benefits because of the program’s progressive benefit structure, which uses three “bend points” of lifetime earnings to pay out benefits at different rates.
“If you just paid back the wealthiest wage earners at that top rate, they’d see some really big checks that they really don’t need, and it wouldn’t address the long-range shortfall,” says Nicole Woo, CEPR’s director of domestic policy. “You’d probably want to create a fourth or fifth bend point that reduces the payouts at the very high end.”
More taxes for little return may not sound fair - until you recall that huge difference in the payroll tax rates Americans now pay. But the wealthy get one more benefit from paying higher taxes, argues Virginia Reno, vice president for income security at the National Academy of Social Insurance.
”We support Social Security because they hope to get benefits someday, but also because we want to live in a society where everyone has basic security in retirement. High-income people have the ability to pay proportionately, and to live in a society where everyone has basic protection.
“Wealthy people should think about the low-income people who contribute to the quality of their live in ways they never see,” she says. “They’re preparing meals for their kids at college, they’re daycare workers or hospital orderlies. Social Security is the only thing they can count on in retirement.”
(The opinions expressed here are those of the author, a columnist for Reuters.)
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Editing by Douglas Royalty)