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Taxing the wealthy is a big topic in Washington these days.
President Joe Biden recently proposed in his 2023 annual budget a so-called billionaire minimum income tax that would increase levies on the country’s wealthiest households.
Under the plan, people with a net worth of $100 million or more would face a 20% tax on their full income, including unrealized appreciation.
But one other proposal kicking around Capitol Hill — to raise taxes on high earners making $400,000 and up a year — went unmentioned in Biden’s budget, and it could help solve Social Security’s funding woes.
Social Security is funded through payroll taxes, which in 2022 apply to wages up to $147,000. Both the employer and employee contribute 6.2% of wages up to that income threshold, which is adjusted annually.
A recent Congressional proposal seeks to apply that payroll tax on wages of $400,000 and up, among other changes, to shore up the program.
The clock is ticking for lawmakers to make changes to ensure the program can continue to pay benefits as promised. The Social Security Board of Trustees estimates the funds could be depleted in 2034, at which point 78% of benefits will be payable.
To shore up the system, leaders face a choice of cutting benefits through changes like raising the retirement age, increasing taxes or doing a combination of both.
Applying Social Security payroll taxes to those above the wage base is a popular idea with the public, and even has its own campaign slogan, “Scrap the Cap,” said Nancy Altman, president of Social Security Works.
How raising the wage base could work
Once a worker crosses the threshold of paying Social Security taxes on the first $147,000 of their annual earnings, their paychecks are no longer subject to those levies.
As a result, workers who are above the earnings threshold may pay Social Security payroll taxes for part of the year only.
“A lot of people don’t even know there is a maximum, and when they find out, they think the law should be changed so that everybody pays in all year,” Altman said.
A Medicare tax of 1.45% also applies to wages. Combined with Social Security, this represents a 7.65% tax paid both by employees and employers and is known as FICA, which stands for the Federal Insurance Contributions Act.
Notably, there is no wage limit for the Medicare tax, after Congress did away with it starting in 1994.
Today, lawmakers could choose to make the same change to Social Security. They could also choose to increase the tax rate from 6.2%.
What changes could be included
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Democrats have proposed reapplying the Social Security payroll tax starting at $400,000 in wages. Earnings up to $147,000 would still be taxed. Then there would be a donut hole or gap where the taxes were no longer applied until wages reached $400,000 and the tax was assessed again.
There are other ways lawmakers could include more wages in the Social Security payroll tax, according to Kathleen Romig, director of Social Security and disability policy at the Center on Budget and Policy Priorities.
That could include simply applying the tax on all wages above $147,000.
Additionally, they could create a surtax specifically for higher earners, and possibly reducing the benefits they receive.
Lawmakers could also choose to apply Social Security payroll taxes to programs that were non-existent when Congress last addressed this issue, such as transit subsidies or flexible spending accounts.
Since the cap was first set, wages at the top have grown dramatically faster.
Social Security payroll taxes initially covered about 90% of wages. To cover that level of wages, the cap would be need to be around $270,000, according to a 2016 estimate.
“Just keeping up with the growing wage inequality in this country, not to mention the other forms of inequality, would close a substantial portion of the financing gap,” Romig said.
Changes to get more expensive with time
The longer Congress waits to act, the less likely it makes raising the taxable wage base by itself enough to solve Social Security’s overall funding issues.
Eliminating the cap was once enough to remove the deficit, according to Joe Elsasser, founder and president of Covisum, a Social Security claiming software company.
Now, even if all wages are taxed, it only covers 60% to 70% of the shortfall, he said.
“Each year we delay reforms, the cost to have tax revenue on current workers meet the need indefinitely goes up,” Elsasser said.
Raising the taxes workers must pay raises questions about intergenerational equity, he said.
“Is it fair to make the next generation support their parents, which is effectively what happens when you’re increasing payroll tax to fund benefits for current retirees?” Elsasser said.
If the payroll tax rate is moved higher than 6.2%, that will mean less take-home pay for workers.
“From an individual planning perspective, the challenge is not to let it crowd out your own retirement savings,” Elsasser said.