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 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2017-2021 2017-2026
Raise Taxable Share to 90 Percent                        
  Change in outlays 0.1 0.2 0.5 0.7 1.1 1.5 1.9 2.5 3.1 3.8 2.6 15.4
  Change in revenues 18.6 60.1 62.5 64.7 67.3 70.1 72.4 75.0 77.7 80.2 273.1 648.4
    Decrease in the Deficit -18.5 -59.9 -62.0 -64.0 -66.2 -68.6 -70.5 -72.5 -74.6 -76.4 -270.5 -633.0
Subject Earnings Greater Than $250,000 to Payroll Tax                        
  Change in revenues 27.2 85.6 90.1 95.2 101.2 107.6 113.7 121.0 129.1 137.1 399.3 1,007.8

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

This option would take effect in January 2017.

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 change in outlays would be for additional payments of Social Security benefits and would be classified as off-budget.

Social Security—which consists of Old-Age and Survivors Insurance and Disability Insurance—is financed primarily by payroll taxes on employers, employees, and the self-employed. Only earnings up to a maximum, which is $118,500 in calendar year 2016, are subject to the tax. That maximum usually increases each year at the same rate as average wages in the economy. The Social Security tax rate is 12.4 percent of earnings: 6.2 percent is deducted from employees' paychecks, and 6.2 percent is paid by employers. Self-employed individuals generally pay 12.4 percent of their net self-employment income.

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 2016, about 82 percent of earnings from employment covered by Social Security fell below the maximum taxable amount.

This option considers two alternative approaches that would increase the share of earnings subject to payroll taxes.

  • The first alternative would increase the taxable share of earnings from jobs covered by Social Security to 90 percent by raising the maximum taxable amount to $245,000 in calendar year 2017. (In later years, the maximum would grow at the same rate as average wages, as it would under current law.) Implementing such a policy change would increase revenues by an estimated $648 billion over the 2017–2026 period, according to the staff of the Joint Committee on Taxation (JCT). (The estimates include the reduction in individual income tax revenues that would result from employers' shifting 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 alternative would be offset by the additional benefits paid to people with earnings above the maximum taxable amount under current law. On net, this alternative would reduce federal budget deficits by an estimated $633 billion over the 10-year period.
  • The second alternative would apply the 12.4 percent payroll tax to earnings over $250,000 in addition to earnings below the level specified by the current-law taxable maximum. The taxable maximum would continue to grow with average wages, but the $250,000 threshold would remain at that level, so the gap between the two would shrink. CBO projects that the taxable maximum would exceed $250,000 in calendar year 2037; after that, all earnings would be subjected to the payroll tax. The current-law taxable maximum would still be used for calculating benefits, so scheduled benefits would not change. This alternative would raise $1.0 trillion over the 2017–2026 period, according to JCT.

An advantage of either approach 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 2016 to 6.3 percent by 2041, CBO projects. But Social Security tax revenues, which already are less than spending for the program, would grow more slowly. In CBO's extended baseline, the combined Old-Age and Survivors Insurance and Disability Insurance trust funds are projected to be exhausted in calendar year 2029. The first alternative, which increases the taxable share of earnings from jobs covered by Social Security to 90 percent, would delay the exhaustion of the combined trust funds by 4 years, to calendar year 2033. The second alternative, which would apply the 12.4 percent payroll tax to earnings over $250,000, would delay the exhaustion of the combined trust funds by 12 years, to calendar year 2041.

In addition, either alternative 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 higher benefit payments for affected workers under the first alternative, but the tax increase would be much larger than the increase in benefits.) The second alternative would be more progressive than raising the taxable maximum because it would affect only those with earnings above $250,000.

A disadvantage of both alternatives is that raising the earnings cap would weaken the link between the taxes that workers pay into the system and the benefits they receive. That link has been an important aspect of Social Security since its inception. Under the first alternative, the increase in benefits would be modest relative to the increase in taxes, and under the second alternative, workers with higher earnings would pay additional taxes that would not increase their benefits.

Another drawback is that some people—those with earnings between the existing taxable limits and the higher thresholds under the first alternative, or those with earnings above the $250,000 threshold under the second alternative—would earn less after taxes for each additional hour worked. Increases in statutory tax rates have two opposing effects among people already working. First, people tend to work fewer hours because other uses of their time become relatively more attractive (the substitution effect). However, people also tend to work more hours because having less after-tax income requires additional work to maintain the same standard of living (the income effect). In CBO's estimation, the first effect would, on balance, be greater than the second effect. The first approach would thus reduce the incentive to work and also encourage taxpayers to substitute tax-exempt fringe benefits for taxable wages. In contrast, people with earnings well above the limit established by the first alternative 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.