Increase the Maximum Taxable Earnings for the Social Security Payroll Tax

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

(Billions of dollars) 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2014-2018 2014-2023
Change in Outlays * * * * 1 1 1 2 2 3 2 10
Change in Revenues 8 40 46 49 51 52 53 55 57 59 194 470
  Net Effect on the Deficit -8 -39 -46 -49 -51 -51 -52 -53 -55 -57 -192 -460

Sources: Staff of the Joint Committee on Taxation; Congressional Budget Office.

Notes: This option would take effect in January 2014. The change in revenues would consist of an increase in receipts from Social Security payroll taxes (which would be off-budget), offset in part by a reduction in individual income tax revenues (which would be on-budget). The outlays would be for additional payments of Social Security benefits and would be classified as off-budget.

* = between zero and $500 million.

Social Security—which consists of Old-Age and Survivors Insurance and Disability Insurance—is financed by payroll taxes on employers, employees, and the self-employed. Only earnings up to a maximum, which is $113,700 in 2013, are subject to the tax. That maximum usually increases each year at the same rate as average wages in the economy.

When payroll taxes for Social Security were first collected in 1937, about 92 percent of earnings from jobs covered by the program were below the maximum taxable amount. During most of the program’s history, the maximum was increased only periodically, so the percentage varied greatly. It fell to 71 percent in 1965 and by 1977 had risen to 85 percent. Amendments to the Social Security Act in 1977 boosted the amount of covered taxable earnings, which reached 90 percent in 1983. That law also specified that the taxable maximum be adjusted, or indexed, annually to match the growth in average wages. Despite those changes, the percentage of earnings that is taxable has slipped in the past decade because earnings for the highest-paid workers have grown faster than average earnings. Thus, in 2011, about 83 percent of earnings from employment covered by Social Security fell below the maximum taxable amount.

This option would increase the taxable share of earnings from jobs covered by Social Security to 90 percent by raising the maximum taxable amount to $177,500 in calendar year 2014. (In later years, the maximum would continue to be indexed as it is now.) Implementing such a policy change would increase revenues by an estimated $470 billion over the 2014–2023 period, according to the staff of the Joint Committee on Taxation. (The estimates include the reduction in individual income tax revenues that would result from a shift of some labor compensation from a taxable to a nontaxable form.)

Because Social Security benefits are tied to the amount of earnings on which taxes are paid, however, some of the increase in revenues from this option would be offset by the additional benefits paid to people with earnings above the maximum taxable amount under current law. On net, the option would reduce federal budget deficits by an estimated $460 billion over the 10-year period.

An advantage of this option is that it would provide more revenue to the Social Security program, which, according to the Congressional Budget Office’s projections, will not have sufficient income to finance the benefits that are due to beneficiaries under current law. If current law remained in place, spending for Social Security would rise from 4.9 percent of gross domestic product (GDP) in 2013 to 6.2 percent by 2038, CBO projects. But Social Security tax revenues, which already are less than spending for the program, would grow more slowly. CBO projects that, in combination, the Old-Age and Survivors Insurance and Disability Insurance trust funds will be exhausted in 2031. Under this option, exhaustion of the combined trust funds would be delayed until 2036.

In addition, this option would make the payroll tax less regressive. People with earnings above the ceiling now pay a smaller percentage of their total earnings in payroll taxes than do people whose total earnings are below the maximum. Making more earnings taxable would increase payroll taxes for those high earners. (That change would also lead to somewhat higher benefit payments for affected workers.)

A disadvantage of this option is that raising the earnings cap would weaken the link between the taxes that workers pay into the system and the benefits they receive (because the increase in benefits would be modest relative to the increase in taxes). That link has been an important aspect of Social Security since its inception. Another drawback is that people with earnings between the existing taxable limits and those under the option would earn less after taxes for each additional hour worked, which would reduce the incentive to work and encourage taxpayers to substitute tax-exempt fringe benefits for taxable wages. In contrast, people with earnings well above the limit established by this option would not see any reduction in the return on their additional work, but they would have less income after taxes, which would encourage them to work more.