Increase the Payroll Tax Rate for Social Security
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||2019||2020||2021||2022||2023||2024||2025||2026||2027||2028||2019-
|Change in Revenues|
|Increase rate by 1 percentage point||44.7||63.8||66.4||69.1||71.8||74.7||77.6||74.8||82.2||85.3||315.8||715.5|
|Increase rate by 2 percentage points||88.8||126.8||132.0||137.4||142.8||148.4||154.2||158.6||163.4||169.6||627.8||1,422.1|
Source: Staff of the Joint Committee on Taxation.
This option would take effect in January 2019.
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).
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 $128,400 in calendar year 2018, are subject to the tax. The 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. Employees have 6.2 percent of earnings deducted from their paychecks, and the remaining 6.2 percent is paid by their employers. Self-employed individuals generally pay 12.4 percent of their net self-employment income.
In 2017, Social Security receipts from payroll taxes totaled $850.6 billion. Of that amount, $806.4 billion was from payroll taxes assessed on employers and employees and $44.2 billion was from payroll taxes assessed on self-employed individuals. The Congressional Budget Office projects that receipts from Social Security payroll taxes will fall slightly as a share of gross domestic product (GDP) between 2017 and 2019, in part because the share of earnings above the maximum taxable amount is projected to increase. After that share stabilizes in 2019, receipts from Social Security payroll taxes are projected to rise as a share of GDP. A major reason for that growth is that wages and salaries are projected to rise as a share of GDP over the next decade.
This option consists of two alternative increases to the Social Security payroll tax rate. The first alternative would increase the rate by 1 percentage point. The second alternative would increase it by 2 percentage points. Those rate increases would be evenly split between employers and employees. For example, for the 1 percentage-point increase, the rate for both employers and employees would increase by 0.5 percentage points, to 6.7 percent, resulting in a combined rate of 13.4 percent. The rate paid by self-employed people would also rise to 13.4 percent.
Effects on the Budget
If implemented, the first alternative would increase revenues by $716 billion from 2019 through 2028, according to estimates by the staff of the Joint Committee on Taxation (JCT). JCT estimates that the second alternative would increase revenues by $1,422 billion over the same period. The estimates presented here incorporate the assumption that total compensation remains unchanged but allow for behavioral responses to the higher tax. (Total compensation comprises taxable wages and benefits, nontaxable benefits, and employers' contributions to payroll taxes.)
If total compensation remains unchanged, then increases in employers' contributions to payroll taxes must reduce other forms of compensation. The decrease in taxable wages and benefits would reduce the income base for individual income and payroll taxes, partially offsetting the increase in employers' payroll taxes. The estimates for the option reflect that income and payroll tax offset.
The higher payroll tax would create an incentive for employers and employees to change the composition of compensation, shifting from taxable compensation to forms of nontaxable compensation. The estimates account for that behavioral response.
The estimates for this option are uncertain primarily because of the underlying projections of income subject to Social Security payroll taxes. The estimates rely on CBO's projections of the economy over the next decade, particularly projections of wages, the income distribution, and employment. Those projections are inherently uncertain.
An advantage of this option is that it would provide more revenues to the Social Security program, which, according to CBO's projections, eventually would not have sufficient income to finance the benefits that are due to beneficiaries under current law. If current law remained in place, Social Security tax revenues, which already are less than spending for the program, would grow more slowly than spending for Social Security. CBO projects that the combined Old-Age and Survivors Insurance and Disability Insurance trust funds would be exhausted in calendar year 2031. Each alternative would extend the insolvency date for the trust funds: The 1 percentage-point increase would delay their exhaustion by about four years, to calendar year 2035, and the 2 percentage-point increase would delay their exhaustion by about nine years, to calendar year 2040.
Another argument in support of the option is that an increase in the tax rate would be simpler to administer than most other types of tax increases because it would require relatively minor changes to the current tax system.
A drawback of the option is that it would encourage people to reduce the hours they work. When statutory tax rates increase, people have an incentive to work fewer hours because other uses of their time become relatively more attractive. (Increases in statutory tax rates can also cause people to work more hours, because having less after-tax income requires additional work to maintain the same standard of living. On balance, however, CBO estimates that the former effect would be greater than the latter effect.)
Another disadvantage of the option is that it would increase the tax burden of lower-income workers relative to that of workers with higher income. That is because a larger share of the income of lower-income households is, on average, from earnings that are below the taxable maximum and thus subject to the Social Security payroll tax. As a result, an increase in the Social Security payroll tax would represent a greater proportion of income for lower-income taxpayers than for higher-income taxpayers. Moreover, because the option would not make any changes to Social Security benefits, the increase in the tax burden would not be offset by greater Social Security benefits.