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||2019||2020||2021||2022||2023||2024||2025||2026||2027||2028||2019-
|Raise Taxable Share to 90 Percent|
|Change in Outlays||0.1||0.3||0.6||1.0||1.4||1.9||2.5||3.2||4.0||4.9||3.4||19.8|
|Change in Revenues||23.9||77.0||81.0||83.4||84.9||86.8||89.0||90.9||92.6||95.2||350.2||804.9|
|Decrease (-) in the Deficit||-23.8||-76.7||-80.4||-82.4||-83.5||-84.9||-86.5||-87.7||-88.6||-90.3||-346.8||-785.1|
|Subject Earnings Greater Than $250,000 to Payroll Tax|
|Change in Revenues||32.7||104.2||111.6||117.6||123.9||131.0||138.7||146.0||153.5||163.4||490.0||1,222.6|
Sources: Staff of the Joint Committee on Taxation; Congressional Budget Office.
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). The 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 $128,400 in calendar year 2018, are subject to the tax. 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.
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 a low of 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. Those amendments 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 83 percent of earnings from employment covered by Social Security fell below the maximum taxable amount.
In 2017, receipts from Social Security 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 that self-employed individuals paid on their earnings. In the Congressional Budget Office's projections, receipts from Social Security payroll taxes 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 increase is that wages and salaries are projected to rise as a share of GDP over the next decade.
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 in calendar year 2019. (In later years, the maximum would grow at the same rate as average wages, as it would under current law.)
The second alternative would apply the 12.4 percent payroll tax to earnings over $250,000 in addition to earnings below the maximum taxable amount under current law. The taxable maximum would continue to grow with average wages, but the $250,000 threshold would not change, 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 from jobs covered by Social Security would be subject to the payroll tax. The current-law taxable maximum would still be used for calculating benefits, so scheduled benefits would not change under this alternative.
Effects on the Budget
Implementing the first alternative, which would raise the maximum taxable amount to $285,000 in calendar year 2019, would increase revenues by an estimated $805 billion from 2019 through 2028, according to the staff of the Joint Committee on Taxation (JCT). Because Social Security benefits are tied to the amount of earnings on which taxes are paid, however, some of that increase in revenues would be offset by 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 $785 billion over the 10-year period. If the maximum taxable amount was adjusted by a different amount, the change in revenues would not necessarily be proportional because earnings are not evenly distributed.
Implementing the second alternative would raise $1,223 billion from 2019 through 2028, according to JCT. The estimates presented here incorporate the assumption that total compensation would remain 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 remained unchanged, then increases in employers' contributions to payroll taxes would have to 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.
In addition, 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 uncertainty surrounding CBO's underlying projections of income subject to Social Security payroll taxes. Those projections rely on CBO's projections of the economy over the next decade—particularly projections of wages, the income distribution, and employment—which are inherently uncertain.
An advantage of either alternative is that it would increase revenues for the Social Security program, which, according to CBO'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, Social Security tax revenues, which already are less than spending for the program, would grow more slowly than spending for Social Security. In CBO's long-term projections of the economy and budget under current law, the combined Old-Age and Survivors Insurance and Disability Insurance trust funds are projected to be exhausted in calendar year 2031. The first alternative, which would increase the taxable share of earnings from jobs covered by Social Security to 90 percent, would delay the exhaustion of the combined trust funds by 5 years, to calendar year 2036. 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 13 years, to calendar year 2044.
In addition, either alternative would make the payroll tax less regressive—that is, each would increase the tax burden on people with higher income. People with earnings above the maximum 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 increase 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 the first because it would affect only those with earnings above $250,000. (After 2037, when the current-law taxable maximum would exceed that threshold, it would affect those with earnings above the taxable maximum.)
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, and those with earnings above the $250,000 threshold under the second alternative—would earn less after taxes for each additional hour worked. For those people, the decline in after-tax earnings would have two opposing effects. On the one hand, the lower earnings for each additional hour worked would make other uses of time relatively more attractive, so people would tend to work fewer hours. On the other hand, people also would tend to work more hours because having less after-tax income requires additional work to maintain the same standard of living. On balance, CBO estimates that the first effect would be greater than the second effect, and thus people in those earnings ranges would work less. However, 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.