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**RSC Policy Brief:**

**The Consequences of Repealing the Social Security Wage Cap**

*June 30, 2008*

*"We put those payroll contributions there so as to give the
contributors a legal, moral, and political right to collect their
pensions and their unemployment benefits."*

**-President Franklin D. Roosevelt**

*\"You and your employer will each pay three cents on each dollar you
earn, up to \$3,000 a year. That is the most you will ever have to
pay..."*

**-Early Social Security Pamphlet**[^1]

**[Background]{.underline}:** According to the Social Security Trustees,
the Social Security Trust Fund has unfunded liabilities over the next 75
years of \$4.3 trillion. In the nearer term, Social Security spending is
projected to increase from 4.3% of GDP in 2007 to 6.1% of GDP in 2035.
The Social Security program is funded by a 12.4% payroll tax, 6.2% on
the employee and 6.2% on the employer. In 2008, the Social Security
payroll tax applies to the first \$102,000 of an employee's income. This
\$102,000 threshold, beyond which wages are not subject to the Social
Security payroll tax, is the Social Security wage cap. Some Democrats,
as a means to address Social Security's financial troubles, advocate
raising or completely eliminating the Social Security wage cap. The
purpose of this policy brief is to analyze these proposals.

**[History of the Social Security Wage Cap:]{.underline}** The cap on
earnings subject to the Social Security tax was included in the Social
Security Act of 1935. During the first thirteen years of Social
Security's existence (1937-1949), a 2 percent tax (1% on employer, 1% on
employee) applied to the first \$3,000 of income. From the 1950s to the
early 1970s, the cap was increased by statute on an irregular basis. In
1972, President Nixon signed into law legislation that increased Social
Security benefits, provided an annual COLA, and indexed the Social
Security wage cap to wage growth. In 1977, the cap was increased by
another \$7,500. In every year since 1982, the cap has increased in line
with wage growth, and under current law, it will continue to do so.

As shown by the chart below, in the seven decades since 1937, the cap on
wages subject to the Social Security tax has increased by 3,150.0%,
increasing from \$3,000 in 1937 to \$97,500 in 2007.

**Figure 1: Social Security Wage Cap by Decade**

![](media/image2.wmf){width="5.375in" height="3.9375in"}

It is worth noting that many provisions in the tax code, which limit tax
liability, do not increase automatically with wage growth. For example,
income tax brackets do not increase in line with wage growth, but
instead with inflation, which is usually lower than wage growth. Other
provisions in the tax code that limit tax liability (such as the AMT
exemption and the child tax credit) are only adjusted by an act of
Congress. Even as currently constructed, the automatic adjustment of the
wage cap to wage growth will cause the federal tax burden to increase.

Proponents of increasing or eliminating the cap on wages subject to the
Social Security tax note that the percentage of wages subject to this
tax has fallen from 90% in 1982, to 85% in 2005, to a projected 83% in
2014. However, this reflects a substantially larger earnings base than
any other period since the creation of Social Security. For example, in
every year between 1950 and 1974, the wage cap caused earnings subject
to the Social Security tax to fall within a range of 71.3% and 81.8%.

**[Rationale for the Social Security Wage Cap:]{.underline}** The Social
Security wage cap has always been a feature of the Social Security
system for two reasons. First, the Social Security program is intended
to have some correlation between what an individual pays into the system
and the value of the benefit that the individual receives. As
[CRS](http://www.congress.gov/erp/rl/pdf/RL32896.pdf) notes:

> "\[H\]aving different bases for contributions and benefits would
> weaken the traditional link between the taxes workers pay into the
> system and the benefits they receive."

Eliminating the cap (assuming no proportionate increase in benefits)
would repeal the link between taxes paid into the system and benefits
received for the projected 21% of Americans that, according to CRS, will
have wages in excess of the current wage cap at some point in their
careers. This would cause Social Security to come closer to resembling a
redistributive welfare program instead of an earned entitlement program.

This is in contrast to some conservative reform proposals such as the
Growing Real Ownership for Workers Act of 2005 (H.R. 3308 from the
109^th^ Congress), which would have dedicated the Social Security
surplus to voluntary, personal accounts. Personal accounts, by their
very nature, have the effect of strengthening the relationship between
tax contributions and benefits received.

Second, the only way to raise or eliminate the cap on Social Security
taxes, while still maintaining the link between taxes paid and benefits
received, is to pay much higher benefits to higher-income individuals.
According to CRS, under such a policy, someone who has lifetime earnings
of \$1,000,000 a year would receive \$162,000 a year in Social Security
benefits. Such a policy would create the perverse result of giving
wealthier seniors Social Security benefits that would in some cases be
more than ten times larger than the current average benefit, and this
extra money would come from a Social Security Trust Fund that---even
with the new revenue---would still have structural financial problems.

The U.S. is not alone in having a wage cap on taxes that fund public
pensions. In fact, [Andrew
Briggs](http://www.aei.org/publications/pubID.27704/pub_detail.asp) of
AEI points out that the U.S. wage cap is 2.9 times the average U.S.
wage, while the average OECD country sets its comparable limit at 1.9
times the average wage.

**[Proposals to Raise Social Security Wage Cap in the 110^th^
Congress:]{.underline}**

*Social Security Forever Act:* Representative Robert Wexler (D-FL) has
introduced legislation, H.R. 5779, to create a new 6% Social Security
tax on earnings above \$102,000 (3% on the employee, 3% on the
employer). The self-employed would be responsible for paying the full
additional 6% tax. This new tax would *not* come with higher benefits
for those required to pay it.

*The "Donut Hole" Option:* Senator Barack Obama has proposed a
[plan](http://blog.washingtonpost.com/the-trail/2008/06/13/obama_clarifies_social_securit.html)
to tax wages at the normal 12.4% rate up to \$102,000, and then 0% from
\$102,000 to \$250,000, and then 12.4% on wages higher than \$250,000.
It is unclear whether Senator Obama's plan would include higher
benefits, and it is hard to imagine such a "donut hole" being unfilled
for long.

*Eliminate the Wage Cap:* A final option would be to eliminate the tax
cap altogether, which would impose the 12.4% Social Security tax on all
earnings, including all earnings above \$102,000.

**[The Federal Tax Burden and Social Security Taxes:]{.underline}** In
2007, federal revenue was 18.8 percent of GDP, above the 18.2 percent of
GDP average of the previous forty years. Federal revenue grew by 14.5
percent in 2005, 11.8 percent in 2006, and 6.7 percent in 2007. Federal
tax collections have increased by \$688 billion or 37 percent since the
end of 2004. Under current law, CBO projects federal revenues will
increase by another \$1.89 trillion or 71% over the next ten years.

In addition, CBO notes, "Without future adjustments, a host of
characteristics of the current tax system will continue to interact with
economic conditions and cause receipts, on net, to grow faster than
GDP." This occurs because the income tax is not indexed for wage growth,
the value of some deductions in the tax code are not indexed for
inflation at all, the large projected increase in the number of
taxpayers hit by the AMT, significant future tax payments have been
deferred such as with IRAs, and finally because under current law the
2001 and 2003 tax cuts expire. In short, if federal tax policy is simply
left on auto-pilot, even with no other action by Congress to increase
taxes, the federal tax burden measured as a percentage of GDP will
increase to levels never before seen in American history.

**Figure 2: Federal Revenue as a Percentage of GDP by Year**

  -------------- -------------- -------------- -------------- --------------
                 **Historical   **2007**       **2018**       **2050**
                 Average**                                    

  **Federal      18.2           18.8           20.3           23.5
  Revenue**                                                   
  -------------- -------------- -------------- -------------- --------------

***Source:** January 2008 CBO [Budget
Outlook](http://www.cbo.gov/doc.cfm?index=8917) and December 2007 CBO*
[*Long-Term Budget
Outlook*](http://www.cbo.gov/ftpdocs/88xx/doc8877/12-13-LTBO.pdf)

To date, the highest figure for federal revenue as a percentage of GDP
is 20.9 percent in 1944, at the height of World War II, and then again
in 2000, during the stock market bubble. Raising or eliminating the wage
cap would cause the federal tax burden to increase even further.

**[The Top Marginal Tax Rate and the Social Security Wage
Cap:]{.underline}** Repealing the Social Security wage cap would
increase the top federal marginal tax rate from 37.9 percent to 50.3
percent. If this tax increase was also done in conjunction with allowing
the income tax rate reductions in the 2001 and 2003 tax cuts to expire,
the top marginal tax rate would increase from 37.9% today to 54.9%. As
Paul Krugman
[notes](http://krugman.blogs.nytimes.com/2008/06/16/campaign-coverage-puzzle/):

> Barack Obama's new Social Security proposal, love it or hate it, is
> huge news; it would push tax rates on some high-income Americans back
> to the levels of the 1970s.

According to the [Tax
Foundation](http://www.taxfoundation.org/news/show/22469.html), the U.S.
marginal tax rate was the 10^th^ lowest of the 30 OECD countries in
2006. Repealing the wage cap and allowing the 2001 and 2003 tax cuts to
expire would cause the U.S. to have the fourth highest marginal tax rate
in the OECD after 2010, behind only France, Sweden, and Denmark.

**[Conclusion:]{.underline}** Proposals to raise or eliminate the wage
cap would have at least two very important consequences. First,
eliminating the wage cap would change the nature of the Social Security
program by repealing the link between the amount of taxes an individual
pays into the system and what an individual receives upon retirement in
Social Security benefits.

Second, in terms of tax policy, eliminating Social Security's wage cap
would be a very large increase to the top U.S. marginal tax rate. As
even some liberal economists (such as Paul Krugman) have noted,
repealing the Social Security wage cap would cause the top marginal tax
rate to increase to levels not seen in the U.S. since the Carter
Administration---eliminating much of the success conservatives have had
in reducing marginal tax rates since 1981.

**[Additional Reading:]{.underline}** For further information on this
issue see:

-   [*CRS: Social Security: Raising or Eliminating the Taxable Earnings
    Base*](http://www.congress.gov/erp/rl/pdf/RL32896.pdf)

-   [*Andrew Biggs, AEI paper: Barack Obama's Social Security Donut
    Hole*](http://www.aei.org/publications/pubID.27704/pub_detail.asp)

-   [*Tax Foundation: In OECD Comparison of Wage Taxes, U.S. Ranking
    Would Slip Badly if 2001 Tax Cuts
    Expire*](http://www.taxfoundation.org/news/show/22469.html)

-   [*Heritage Foundation: Keep the Social Security Wage Cap: Nearly a
    Million Jobs Hang in the
    Balance*](http://www.heritage.org/Research/SocialSecurity/cda05-04.cfm#_ftn7)

-   [*Amity Shlaes, Washington Post: Fixing Social Security the FDR
    Way*](http://www.washingtonpost.com/wp-dyn/content/article/2007/11/25/AR2007112501545.html)

**[RSC Contact:]{.underline}** Brad Watson, 202-226-9719,
<brad.watson@mail.house.gov>

[^1]: Amity Shlaes, "Fixing Social Security the FDR Way," *Washington
    Post* November 26, 2007, available online at
    <http://www.washingtonpost.com/wp-dyn/content/article/2007/11/25/AR2007112501545.html>

    (accessed June 30, 2008).