Raising the Taxable Maximum

Workers and their employers pay Social Security payroll taxes only on earnings that do not exceed a certain level, known as the Social Security taxable maximum (or “contribution and benefit base”). Boosting the taxable maximum could substantially improve the system’s financing but would reduce the returns high earners receive on their payroll tax contributions, possibly undermining political support for the program.

How Does the Taxable Maximum Work?

• In 2010, the annual taxable maximum for Social Security is $106,800.
  • The taxable maximum increases each year with average wages in the economy.
  • The taxable maximum was eliminated for Medicare payroll taxes in 1993.
• About 9.0 percent of men and 3.0 percent of women with earnings covered by Social Security earned more than the taxable maximum in 2007 (Annual Statistical Supplement 2009).
• Social Security bases benefits on earnings up to the taxable maximum.
• The taxable maximum makes the Social Security payroll tax regressive, because low earners pay higher shares of their earnings in taxes than high earners.
  • The Social Security benefits formula, however, is progressive. The formula replaces a larger share of earnings at the bottom than at the top of the distribution. A full assessment of how Social Security redistributes income must take into account taxes paid, wages replaced, and the relatively high mortality of low-income people, who generally receive retirement benefits for less time than high-income people (Cohen et al. 2004; Smith et al. 2004).

Why Raise the Taxable Maximum?

• Between 1983 and 2006, the share of total wages covered by Social Security and subject to tax has declined from almost 90 percent to about 83.6 percent because earnings have grown rapidly near the top of the earnings distribution.
• If the share of earnings covered by Social Security had remained constant over the 1983 to 2009 period, the taxable maximum would be about $213,000 in 2009 (Wade 2009).
• Higher earners tend to live and receive benefits longer than lower earners. Raising the taxable maximum would partly offset this advantage.
  • One recent study estimates that the difference in life expectancy between those in the most- and least-deprived U.S. socioeconomic groups is 4.1 years at age 15 and 1.6 years at age 65 (Singh and Siahpush 2006).
  • Earners with many years at the taxable maximum nonetheless tend to get relatively low returns to their contributions because the benefit formula is progressive.

Would Raising the Taxable Maximum Increase Benefits and Offset Revenue Gains?

• Most proposals to increase the taxable maximum would raise benefits for affected workers by counting earnings above the old cap in the benefit formula.
• Social Security’s progressive benefit formula, with its relatively low replacement rates at higher lifetime earnings levels, would limit any additional benefits for higher-income workers.
• Congress could alter the benefit formula if it increased the taxable maximium.

Why Keep the Current Taxable Maximum?

• Higher payroll taxes might discourage high earners from working, but recent evidence suggests that the effect would be modest (Liebman and Saez 2006).
• Employers might respond by substituting cash wages with noncash compensation that is not taxable, such as more generous fringe benefits (health plans, vacation time, etc.).
• Higher earners would get lower returns from their Social Security payroll tax contributions, possibly undermining political support for the system.

What Would Be the Impact on Social Security’s Long-Term Fiscal Deficit?

• Social Security’s actuaries project that eliminating the cap would balance the system at the end of the 75-year horizon if workers with earnings above the current cap were not credited for any of the additional taxes they paid. Social Security would be nearly in balance after 75 years if it increased benefits for high earners (figure 1).
• Raising the cap to 90 percent of payroll and crediting the additional taxes paid toward higher benefits (assuming current law’s progressive replacement rates) for high earners would eliminate less than half of the long-run deficit (figure 1).

Source: OCACT (2008), based on intermediate assumptions of the 2008 Trustees’ Report; policy change effective 2009.

Notes: “All earnings” refers to options in which all earnings above the taxable maximum in OASDI-covered employment would be subject to payroll tax. “Cover 90% total” refers to options in which 90% of total earnings in OASDI-covered employment would be subject to payroll tax. This is roughly equivalent to increasing the taxable maximum for 2009 (the year the simulated change first takes effect) from $94,200 to $213,000. “Benefit increase” refers to options in which newly-taxed earnings above the taxable maximum would be credited toward benefits. “No benefit increase” refers to options under which these newly-taxed earnings would not increase benefits.

Who Has Proposed Raising the Taxable Maximum?

• Former Senator John Edwards proposes increasing the taxable maximum, but his plan would only affect workers earning more than about $200,000 per year. It includes a “doughnut hole” that exempts from Social Security payroll taxes earnings between the current cap and $200,000.
• President Barack Obama also suggests raising the taxable maximum and has mentioned a doughnut-hole approach in some appearances (for example, a February 25, 2008, appearance in Cincinnati). The White House website (as of February, 2009) discusses the possibility of increasing the payroll tax rate between 2 and 4 percent (combined employer and employee) for those making over $250,000.
• Several prominent proposals designed to return the system to long-run fiscal balance would increase the taxable maximum, including the following:
  • Altman (2005);
  • Ball (2007);
  • Diamond and Orszag (2005);
  • Liebman, MacGuineas, and Samwick (2005).

See the Following Reports to Learn More:

Cohen, Lee, C. Eugene Steuerle, and Adam Carasso. 2004. “Redistribution under OASDI: How Much and to Whom?” In Strengthening Community: Social Security in a Diverse America, edited by Kathleen Buto, Martha Priddy Patterson, William E. Spriggs, and Maya Rockeymoore.  Pp. 103-113. Washington, DC: Brookings Institution Press.

Smith, Karen, Eric Toder, and Howard Iams. 2004. “Lifetime Distributional Effects of Social Security Retirement Benefits.” Social Security Bulletin 65(1): 33–61.

Other References:

Altman, Nancy J. 2005. The Battle for Social Security: From FDR’s Vision to Bush’s Gamble. Hoboken: John Wiley and Sons. Summary available at http://www.thebattleforsocialsecurity.com/plan.php.

Ball, Robert M. 2007. “Meeting Social Security’s Long-Range Shortfall: A Golden Opportunity for the New Congress.” http://robertmball.org.

Office of the Chief Actuary, Social Security Administration (OCACT). 2008. Provisions that Could Change the Social Security Program. http://www.ssa.gov/OACT/solvency/provisions/index.html

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.

Liebman, Jeffrey, Maya MacGuineas, and Andrew Samwick. 2005. “Nonpartisan Social Security Reform Plan.” http://www.ksg.harvard.edu/jeffreyliebman/ lms_nonpartisan_plan_description.pdf.

Liebman, Jeffrey, and Emmanuel Saez. 2006. “Earnings Responses to Increases in Payroll Taxes.” http://www.ksg.harvard.edu/jeffreyliebman/ liebman_saez_october.15.2006.pdf.

Singh, Gopal K., and Mohammad Siahpush. 2006. “Widening Socioeconomic Inequalities in U.S. Life Expectancy.” International Journal of Epidemiology 35: 969–79.

Social Security Administration, Office of Policy. 2008. Annual Statistical Supplement 2009 to the Social Security Bulletin.Washington, DC: Author.

Wade, Alice H., J. Patrick Skirvin, and William M. Piet. 2005. “Computing the Ratio of Social Security Taxable Earnings to Covered Earnings; Implications for Provisions to Raise the Contribution and Benefit Base—Information.” http://www.ssab.gov/documents/Taxable-Ratio-Computations-092905.pdf.

Wade, Alice H.. 2009. Personal correspondence.

White House. “Seniors and Social Security.” http://www.whitehouse.gov/agenda/seniors_and_social_security/

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