Urban InstituteRetirement Policy Center

Raising the Payroll Tax Rate

Increasing the payroll tax rate that finances Social Security would improve the system’s finances, but could discourage work.

Background

Both employers and employees currently pay Federal Insurance Contributions Act (FICA) payroll taxes of 6.2 percent to Social Security on covered earnings, up to the taxable maximum

  • The tax consists of a 5.3 percent levy for retirement and survivors’ benefits from the Old-Age, Survivors Insurance program (OASI) and a 0.9 percent levy for disability benefits from Disability Insurance (DI).
  • Self-employed individuals pay both the employer and employee shares, totaling 12.4 percent, under the Self-Employment Contributions Act (SECA).
  • Although employers nominally pay half of the payroll tax, most economists argue that workers bear the tax’s full cost, with employers paying them less than they otherwise would to offset their tax payments.
  • The total payroll tax rate increased steadily between 1955 and 1990, and has not been permanently changed since then (figure 1). In 2011 and 2012, Congress temporarily reduced payroll taxes and made up the lost income by transfers from elsewhere in the budget.
    • The payroll tax rate increased in 1957 to finance the new DI program, and the portion of the total tax rate that covers these benefits shifted slightly in the 1990s.

Payroll Tax Contribution Rates for Employees and Employers, 1937-2013

Why Raise the Payroll Tax?

  • Raising the payroll tax would minimize the need to cut benefits to achieve program solvency.
  • If tax rates do increase, raising them sooner rather than later would spread the cost and effects over more generations.

What Are the Drawbacks of Raising the Payroll Tax?

A higher tax rate (with the same benefit formula) would reduce the return on taxes paid. Some workers currently receive little or no return on their contributions, and a higher tax rate may discourage them from working.

  • For example, those who have already worked for 35 years and who will earn less in year 36 than in the previous 35 years receive no additional return from the taxes they pay in year 36.
  • Some workers who earned substantially less than their current or former spouses—and who will thus receive spouse or survivor benefits—receive no return on their payroll tax contributions.
  • Most employers could pass payroll tax increases to employees (by reducing wages) or to consumers (by increasing prices for goods and services). Employers that pay the minimum wage could not reduce wages and might respond to a payroll tax increase by laying off some workers or hiring fewer new workers in the future.
  • Because payroll taxes are regressive, higher rates may increase the lifetime regressivity in the system.

How Much Would Raising the Payroll Tax Reduce Social Security’s Long-Term Fiscal Deficit?

The amount of additional revenues depends on the specific proposal.

  • Social Security Administration actuaries project that immediately increasing the payroll tax by 2.66 percentage points (for employers and employees combined) would keep the system in balance for 75 years (Board of Trustees 2013).
  • The rate increases required to balance the system would be much higher if Congress waits (for example until 2020) to boost the payroll tax (see, for example, Chaplain and Wade 2005).

Who Has Proposed Increasing the Payroll Tax Rates?

Several prominent proposals designed to bring the system into long-run fiscal balance include increasing the Social Security contribution rates. These include the following:

  • One of the plans of the 1994-1996 Advisory Council on Social Security;
  • Diamond and Orszag (2004).

Other References:

Advisory Council on Social Security [1994-1996]. 1997. Report of the 1994-1996 Advisory Council on Social Security. Volume 1: Findings and Recommendations. Volume 2: Reports of the Technical Panel on Trends and Issues in Retirement Savings Technical Panel on Assumptions and Methods and Presentations to the Council. Washington, DC: Author.

Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance [OASDI] Trust Funds. 2012. “2012 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds.” Washington, DC.

Chaplain, Chris and Alice H. Wade. 2005. “Estimated OASDI Long-Range Financial Effects of Several Provisions Requested by the Social Security Advisory Board—INFORMATION.” Memorandum to Steve Goss. http://www.ssab.gov/documents/advisoryboardmemo--2005tr--08102005.pdf.

Diamond, Peter A. and Peter R. Orszag. 2004. Saving Social Security: A Balanced Approach.  Washington, DC:  Brookings Institution Press. Summary available at: http://www.brookings.edu/views/papers/orszag/200504security.pdf.

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Last updated June 2013.

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