Function 650 - Social Security
Increase the Maximum Taxable Earnings That Are Subject to Social Security Payroll Taxes
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
|Decrease (-) in the Deficit
|Raise the taxable share to 90 percent of earningsa
|Subject earnings greater than $250,000 to payroll taxes
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 $147,000 in calendar year 2022, are subject to the taxes, and only earnings below the maximum are used to determine benefits. 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 2021, receipts from Social Security payroll taxes totaled $952 billion. Of that amount, $901 billion was from payroll taxes assessed on employers and employees, and $51 billion was from payroll taxes that self-employed individuals paid on their earnings.
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 declined in the past decade because earnings for the highest-paid workers have grown faster than average earnings. Thus, in 2020, about 83 percent of earnings from employment covered by Social Security fell below the maximum taxable amount.
This option consists of two alternatives 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 2023. (In later years, the maximum would grow at the same rate as average wages, as it would under current law.) Increases in the taxable maximum would increase scheduled benefits for affected workers.
- 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. (For example, in 2023, all earnings below $160,200—the taxable maximum for that year—would be taxed, as would earnings above $250,000. Earnings between $160,200 and $250,000 would not be taxed.) 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. The Congressional Budget Office projects that the taxable maximum would exceed $250,000 in calendar year 2036; after that, all earnings from jobs covered by Social Security would be subject to payroll taxes. 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
According to the staff of the Joint Committee on Taxation (JCT), implementing the first alternative would raise the maximum taxable amount to $300,000 in calendar year 2023 and increase revenues by an estimated $692 billion from 2023 through 2032. 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 $670 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 decrease the deficit by $1.2 trillion from 2023 through 2032, according to JCT.
Although the estimates presented here reflect the assumption that total compensation would remain unchanged, they 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 taxes would create an incentive for employers and employees to seek to change the composition of compensation by shifting from taxable compensation, such as wages and salary, to forms of nontaxable compensation, such as employment-based health insurance. The estimates account for that behavioral response.
Uncertainty About the Budgetary Effects
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, income distribution, and employment—which are inherently uncertain. However, CBO's projections of wages are typically less variable than its projections of other sources of income, such as capital gains realizations or corporate profits.
By making more earnings subject to Social Security payroll taxes, both alternatives, in a given year, would increase taxes for households with higher income. The first alternative would increase taxes for all individuals with earnings above the current-law taxable maximum, whereas the second alternative would affect only those with earnings above $250,000. (Because the $250,000 threshold would be fixed, an increasing number of people would face higher taxes over time. After 2036, when the current-law taxable maximum would exceed that threshold, it would affect those with earnings above the taxable maximum.)
The Social Security program, on net, is progressive—that is, the benefits received from the program, measured relative to taxes paid into the program over the beneficiary's lifetime, tend to be higher for lower-income households than for higher-income households. When considered in isolation, Social Security taxes are regressive—that is, people with higher earnings, in particular those with earnings above the taxable maximum, pay a smaller percentage of their total earnings in Social Security payroll taxes than those with lower earnings. The regressivity of Social Security taxes is counterbalanced by the progressivity of Social Security benefits. Specifically, people with lower earnings during their lifetime tend to receive a larger share of their earnings in benefits over their lifetime. Two factors contribute to the progressivity of benefits: First, the benefit formula replaces a larger share of earnings for people with lower lifetime earnings; and, second, people with lower lifetime earnings are more likely than average to receive disability benefits. Those factors are partially offset by the fact that people with higher lifetime earnings tend to live longer than average, which means that they collect retired-worker benefits for more years.
By making more earnings subject to Social Security payroll taxes, both of this option's alternatives would increase taxes on people with high earnings and therefore would increase the progressivity of the program overall. Even under the first alternative, which would increase benefits for affected workers, the additional benefits would be significantly smaller than the increase in taxes; thus, it would increase the progressivity of the program.
In addition to having the behavioral effects reflected in conventional budget estimates, such as the ones shown above, changing the share of earnings subject to Social Security payroll taxes would also affect people's incentive to work. Those with earnings between the existing taxable limit 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. The decline in after-tax earnings would have opposing effects. On the one hand, people would tend to work fewer hours because lower earnings would make other uses of their time relatively more attractive. On the other hand, because their after-tax income would decline, they would also tend to work more hours to maintain the same standard of living. On balance, CBO estimates, the first effect would be greater than the second effect, and thus people in those earnings ranges would work less.
Under the first alternative, the incentive to work would also change for people with earnings above the new higher limit. Those people would not see any reduction in the return on their additional work because their income would exceed the taxable maximum. However, they would pay more in payroll taxes, so they would still experience a decline in their after-tax income. As a result, that group would work more.
Either alternative 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 benefits. 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 2033. If the trust funds were exhausted, then the Social Security Administration would still be able to pay some benefits, but it would not have the authority to make payments in excess of the payroll taxes received each year. 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 4 years, until calendar year 2037. 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, until calendar year 2046.