FICA tax Archives - Jane the Actuary

December 19, 2021December 30, 2024 Jane the Actuary Retirement

Forbes post, “Should Poor Families Be Given Tax Relief On Their Social Security FICA Tax? Spoiler Alert . . .”

Originally published at Forbes.com on December 19, 2021.

It’s already been done.

Or at least, depending on your point of view.

Here’s the scoop:

The Earned Income Tax Credit is a federal benefit paid to low-income workers, with benefits varying by family size. Unlike SNAP/food stamps and similar benefits, it is intended as a work incentive by paying benefits only to the working poor, as a percent of income up to a cap. For example, a poor taxpayer/couple with two children receives a credit of 40% of their earnings up to a maximum of $5,980, at which point it gradually phases out until the credit is totally eliminated at an income of $42,000. Benefits are primarily targeted at families with children, but very poor childless taxpayers receive up to $543, or, temporarily due to the American Rescue Plan Act, $1,502. This tax credit is fully refundable, which means that for taxpayers who do not owe any income tax at all, or owe less than the value of the EITC, they are paid out the value of the credit, or what’s left of it. (Some helpful links are at the Tax Policy Center, which includes a nice visual; the National Conference of State Legislatures, which provides information on state versions of the benefit as well; and, of course, the IRS itself.)

And, as it happens, the EITC is approaching its 50th birthday, having made its first appearance in 1975, as a temporary benefit, part of a tax cut package intended as economic stimulus, alongside other credits, rebates, and exemptions. It was then extended multiple times and made permanent in 1978. (See “The Earned Income Tax Credit (EITC): A Brief Legislative History,” prepared by the Congressional Research Service.)

What was the purpose of the credit? In some respects, just as now, it was simply meant to aid poor families. But if we phrase the question a bit differently and ask, what was the rationale behind the credit, we have our answer straight from the legislation-authors themselves:

“The credit is set at 10% [of the first $4,000 in income] in order to correspond roughly to the added burdens placed on workers by both employee and employer social security contributions.” ($4,000 in wages in 1975 is equivalent to about $26,000 now, when adjusted for wage increases over time and the FICA tax rate at the time was 5.85% each for employer and employee.)

Of course, this has long been forgotten, even as the EITC itself has increased in value over the years, and benefits for childless individuals added.

And in the meantime, politicians and policy experts debate whether Social Security is a regressive tax because the wage ceiling caps the tax that the highest earners pay. Here’s the Center for Budget and Policy Priorities:

“Social Security’s payroll tax is regressive, because of its flat rate and its cap, so low- and moderate-income taxpayers pay more of their incomes in payroll tax than do high-income people, on average.”

So how should this bit of history affect how we think about our current taxes and benefits for the poor? Should the fact that the EITC credit was originally designed to offset the FICA/Social Security tax for the poor have any wider significance in future discussions of Social Security benefits and taxes, or is this a mere historical curiosity? Was the offset of Social Security taxes ever even “real” in the first place, since it only ever served as a rationale for the credit rather than having been written into the formula for the tax directly?

This may seem to be a historical curiosity of no future relevance, but, with reports that the Build Back Better bill is dead in its current form, and with debates likely to come on provisions such as the Child Tax Credit, the expanded EITC, and, eventually, Social Security funding itself, we would do well to bear some of this history in mind.

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

September 9, 2020 Jane the Actuary General Interest, Retirement

Forbes post, “Worried About The Payroll Tax Deferral? Here’s A Solution To Consider.”

The payroll tax deferral has people worried. Here’s a work-around.

February 13, 2019January 5, 2025 Jane the Actuary Retirement

Forbes post, “How To ‘Scrap The Cap’ The Right Way”

Originally published at Forbes.com on February 13, 2019.

It is, so Twitter tells me, “Scrap the Cap Day” — the day when Social Security expansion activists are out in force promoting the idea that, because someone earning a million dollars in wage income would hit the Social Security ceiling today, it’s a clear proof that we need to eliminate the ceiling itself. The Center for American Progress chose today to issue a report on the topic and Senator Bernie Sanders chose today to unveil his Social Security legislation, which, as described by CNN, boosts benefits by means of an additional 12.4% payroll tax on earned income above $250,000 as well as a 6.2% tax on investment income for singles with total income above $200,000, or $250,000 for couples, in the same fashion as the existing Medicare surtax.

(This legislation is further described as a reintroduction of his 2017 bill, which sets a minimum benefit after 30 years of eligible employment at 125% of the single-person poverty measure, or $31,225 for a two-person household, indexed at national wage increases; indexes Social Security by the CPI – E, a form of CPI specifically reflecting the spending of the elderly; but does not make any provision for the indexing of the thresholds for the payroll or Medicare surtax.)

Now, this isn’t new, and I’ve addressed the issue in an article last year, but at the risk of repeating myself, sure, we can “Scrap the Cap.” But if we do, we need to be honest about it.

First, we need to acknowledge that Social Security would no longer be a Social Insurance program as conventionally understood. Readers of that prior article will recall that we are already outside the norm in terms of the way countries fund their pension systems, at least with respect to systems which resemble ours in terms of providing accruals based on pay and work history. Their ceilings are much lower — to take one example, in Canada, the ceiling is CAD 57,400 (about USD 43,000).

Now, it does appear that the conventional wisdom that people won’t accept Social Security as a “welfare program” may no longer be true — after all, there is considerable interest in the federal government providing all manner of services for residents, from medical care to free child care and tuitionless-universities. But without getting bogged down in that debate, we need to at least acknowledge what’s on the table.

Second, if we’re to abandon the Social Security ceiling, then there’s really no reason to tie Social Security taxes to specifically earned income or a payroll tax. In that event, it’s far more practical to simply increase income tax rates the requisite amount and collect the tax revenues along with all other taxes. (Again, I raised the issue with respect to Medicare earlier as well.)

And, finally, once we abandon the connection between earnings and Social Security that’s inherent in the elimination of the Social Security ceiling and the taxation of investment income, and once we demand that the upper middle class and wealthy “pay their fair share” — that is, pay more in than they get out in benefits — then the entire formula is due for a re-think, as, again, the most honest way to deliver benefits in such a system is with a flat dollar amount, whether that’s means-tested and phased-out with income (Australia), part of a two-element system alongside a wage-based system (Canada), or a simple flat benefit for everyone (the Netherlands). And the size of such a benefit will have to be determined, not in isolation, but by evaluating the system’s cost and retiree living standards alongside the needs of families with children, the disabled, and the poor.

October 25, 2018January 5, 2025 Jane the Actuary Retirement

Forbes Post, “Social Security, The FICA Tax Cap, And Having Your Cake And Eating It Too”

Originally published at Forbes.com on October 25, 2018.

Every time I write about Social Security and its financial woes, I inevitably get comments that the entire shortfall can be solved simply by eliminating the cap on FICA taxes, so that the wealthy pay “their fair share.” After all, the Medicare portion of FICA has already had cap removed, so why not do the same for Social Security?

Here are some key facts:

In 2019, the maximum taxable earnings for Social Security will be $132,900, according to recently-released figures. Below this level, all Americans pay 6.2% of their earned income into Social Security, and their employer pay another 6.2%. Self-employed workers pay 12.4%.

According to The Social Security Game, by the American Academy of Actuaries (it’s fun; you should try it), if the cap were eliminated and earnings above the cap were not credited with Social Security benefit accruals, it would make up for 88% of the shortfall. If high-income workers did receive accruals based on their above-cap pay, it would only make up for 71% of the shortfall.

The Social Security benefit formula is structured to be “progressive” — that is, lower-income earners accrue benefits at a higher rate relative to their income than higher-income earners. Here’s how it works: all of your income as recorded by the Social Security Administration is indexed, which means it’s adjusted to 2018 based on national average wage increases since the year you earned it. Then the highest 35 years are averaged together (if you had less than 35 years of work, there are 0s included in the average), and then your benefit is 90% of the first $11,112 of your average indexed earnings, 32% of the next level of earnings up to $66,996, and 15% of earnings higher than this level. (See The Motley Fool for these updated-to-2019 figures.) It’s the same idea as marginal tax rates, except in reverse. Which means that, while it goes without saying that if high-paid workers simply paid in more taxes without any new accrual, the additional taxes collected simply subsidize everyone else, it’s also the case that even if higher earners accrued benefits on this income, they would still be heavily subsidizing lower earners — otherwise this wouldn’t be remedying the shortfall.

Removing the ceiling is consistently popular in polls. For example, a 2017 poll by the National Committee to Preserve Social Security and Medicare found that 61% of likely voters “strongly” and 13% “not so strongly” favored a proposal to “gradually require employees and employers to pay Social Security taxes on all wages above $127,000, which they don’t do now” and an even higher percentage — 69%/10% — favored a proposal to “increase Social Security benefits by having wealthy Americans pay the same rate into Social Security as everyone else.” An admittedly-leading question in a 2016 poll found that 72% of respondents supported “increasing — not cutting — Social Security benefits by asking millionaires and billionaires to pay more into the system.” And a more academic but somewhat older analysis from 2014 found that 39% of Americans strongly favored and 40% somewhat favored eliminating the cap.

Looking at this can make it appear as if it’s a no-brainer to remove the cap. Only the rich pay, and everyone else benefits. Yes, they might whine that their taxes go up by 12.4% with nothing to show for it and they’re already paying higher rates, but better that than raise taxes across-the-board or force the elderly to cope with benefit cuts.

But what about the conventional wisdom that says that we need to keep the payroll tax cap (and in addition reject means testing) in order to get broad support of the system as one in which everyone contributes their fair share and has earned their benefits rather than receiving welfare?

How can such large proportions of Americans support making a change that fundamentally undoes this “earned benefits” design to Social Security, especially when the conventional wisdom is that Americans believe that, not only have they earned their benefits, but that the money they contributed was set aside to fund their own personal retirement benefits (or, alternately, would have been had Congress not “stolen” it)?

Is this cognitive dissonance? Are Americans foolishly, even ignorantly, clinging to their belief that they earn their benefits fair-and-square even when their support of removing the cap says they believe the rich should pay for everyone else? Do they want to have their cake and eat it too, by collecting subsidies while still insisting they’ve stood on their own two feet all along?

I don’t think so.

After all, a 2017 poll found that 48% of Americans support the idea of a universal basic income, up from only 10% a decade ago, when described as a way to help people who lose their jobs due to AI. Another poll found 38% somewhat or strongly supported a $1,000/month government check paid for with a tax hike on those earning $150,000 or more.

These UBI supporters are still in the minority, but the idea’s popularity is increasing, and it appears to be just one way out of many in which people are growing increasingly comfortable with the idea that the middle-class should receive government benefits, not (just) the poor. And once people are comfortable with the idea of “middle class welfare,” then it stands to reason that they’d consider the right solution to the funding deficit to be one requiring the wealthy to top up the system however much is needed? In such a case, they might be viewing their benefits as “earned” in a more metaphorical/symbolic sense, in which they have a right to them by having been a hardworking American during their working lifetime, regardless of what the math shows.

If the payroll tax cap is removed, it will not be a matter of having the wealthy pay “their fair share.” It will be a shift towards, or a recognition of (depending on your perspective) FICA taxes being taxes, nothing more or less. And in that case, why not integrate it all into our regular income tax structure, with the same marginal tax rates, deductions, taxation of investment income, and the rest?

Side note: I tried to find polling on the extent to which Americans understand that Social Security is fundamentally a pay-as-you-go system with modest reserves having been built up by past surpluses, rather than a genuinely prefunded system, and is a system with significant subsidies from one group to another (not just by the benefit formula, but subsidies from singles to families and from dual-earner to single earner couples, as well), but there’s not much out there. Polls intending to determine Social Security knowledge, such as this Mass Mutual survey, ask about such practical items as retirement ages and spousal benefits. One 2010 survey does ask a more basic question and finds that roughly a quarter of Americans believe that benefits are based on contributions plus interest, one half either answer correctly or a rough approximation of the correct answer — that is, either an average of the highest 35 years of earnings or a private pension-like 5 year average pay times working years — and one quarter don’t know; it does not ask whether people think the system is funded or pay-as-you-go, or whether they think their benefits are proportionate to their income. But without more survey questions, we’re left to draw conclusions from such sources as viral Facebook posts, including one, a variant on a Snopes-fact-checked version, that came across my Facebook feed recently and insisted, “This is NOT a benefit. It is OUR money , paid out of our earned income! Not only did we all contribute to Social Security but our employers did too ! . . . This is your personal investment.”

April 28, 2018January 12, 2025 Jane the Actuary Retirement

Forbes post, “So, Hey, Why Not Just Remove The Social Security Earnings Cap?”

Originally published at Forbes.com on April 28, 2018.

Am I stuck in a rut and giving every article a rhetorical question title? Maybe. But I wanted to address a basic “fixing Social Security” question that one hears regularly: “the fix for Social Security is simple; all we need to do is remove the earnings ceiling and we can not only pay for Social Security as it is, but even build in enhancements.”

And, in fact, that’s the standard funding mechanism of Democrat-sponsored Social Security proposals. As referenced in an earlier article, in 2017, Senator Bernie Sanders has introduced not-going-anywhere legislation to tax wages and investment income above $250,000 and direct the proceeds to Social Security to extend solvency and boost benefits. Now, as of last week Monday, Senators Chris Van Hollen (D-Md.) Richard Blumenthal (D-CT) introduced legislation, the “Social Security 2100 Act,” the text of which appears to be modeled off earlier legislation which applies Social Security taxes to income over $400,000 (with no apparent inflation adjustment) with trivial benefit accruals. (The proposal also includes other changes including setting a minimum benefit at 125% of the single individual poverty line, that is, $18,825, for a 30-year working lifetime with average-wage increases afterwards, increasing employer and employee contributions by 1.2 percentage points in a graded fashion, and merging the Old Age and Disability Trust Funds into a single Trust Fund.)

To be sure, neither of these proposals stand much of a chance of being taken up by the Republicans but it seems relevant to address this issue sooner rather than later. And, to be fair, the math does work, more or less. The amateur Social Security reformer can take a look at the Social Security Game, put together by the American Academy of Actuaries, which reports that eliminating the ceiling solves 88% of the gap.

A few international comparisons

To begin with, readers should know that the idea of an earnings ceiling is nearly universal and that the relatively high American ceiling is an outlier. Interested readers can find summaries of Social Security provisions at Social Security Programs Throughout the World, at the Social Security website.

Our nearest neighbor, Canada, has a ceiling of CAD 55,900 (USD 43,400).

Germany’s ceiling is EUR 74,400 (64,800 in the former East Germany, USD 90,000/78,422) as of 2016.

Sweden, SEK 478,551 (USD 55,000)

The Netherlands, EUR 33,715 (USD 40,800).

In the United Kingdom, there isn’t a ceiling but there is a breakpoint at which employee contributions drop to a much smaller level (from 12% to 2%); that’s GBP 43,000 (USD 59,470).

And, to be sure, there are other countries in which the system is funded rather differently: Norway and Ireland, for instance, each collect payroll taxes on one’s entire income. Australia funds its (means-tested) system wholly from general revenues, and the first of Canada’s two parts in its system is also funded from general tax revenues. Heck, even my own pet proposal for Social Security reform funds its flat first-tier benefit from general revenues, and, to be perfectly honest, my cynical expectation is that the most likely resolution of the future Social Security funding gap will simply be for the federal government to pick up the difference with general tax revenues. But to remove the ceiling while keeping other elements of the system unchanged would be a deliberate choice that would take the United States outside of mainstream practice, not bring it into the mainstream.

Are Social Security benefits earned?

The longstanding argument for the existence of a cap in the first place is that Social Security is not a welfare program but an insurance system; it happens to be run by the government, but, just like participating in a private sector insurance system, you earn your benefits and receive your fair share, in terms of retirement income and protection against such events as disability or the death of a provider. If the cap were removed, it would be plain to see that this is just another government benefit, with higher earners subsidizing lower earners by virtue of the lower benefit accrual for above-bendpoint wages, just as already it’s becoming acknowledged that single workers subsidize low-earning married workers. Would this be the deathknell of support for Social Security? Not if Medicare is any indicator — despite the removal of the FICA ceiling for Medicare in 1994 and the addition of the Obamacare taxes in 2013, Americans still hold the firm conviction that they have earned their Medicare benefits, fair-and-square. (See Does The Medicare Payroll Tax Still Make Sense?)

But are we willing to be honest about the impact of removing the cap in our public discourse? If someone earning greater than $127,000 annually pays taxes on their whole salary, then they’re subsidizing lower earners. (Even without discussing the mechanics of Social Security, it’s plain to see that there’s a subsidy, or else simply increasing income subject to tax would grow the program overall but wouldn’t improve its sustainability.) And if they are doing the subsidizing, then other recipients are, in fact, not earning their benefits fair-and-square, but are receiving subsidies. Maybe we’re still OK with that, and maybe we can recast it as, “the rich subsidize the poor and we, the middle class, pay in what we get out.”

But if that’s the case, then why stop with removing the ceiling? These proposal amount to raising taxes by 12.4% on wages above $127,000, or $250,000 or $400,000. Why not, then, apply the tax to investment or other non-employment earnings?

And, more importantly, however much we’ve decided that funding retirement income for the elderly is an important objective, there are multiple other competing objectives. Without trying to start an argument on fair taxation levels, it’s plain to see that you can’t spend the same money twice. If we are to discuss increasing marginal taxes by 12.4%, is there really a national consensus that it should all be directed to Social Security? What about healthcare? Education? Daycare subsidies? Parental leave? Infrastructure? Affordable housing?

To paraphrase a certain former president, “It’s the opportunity cost, stupid.”

April 16, 2018January 12, 2025 Jane the Actuary Retirement

Forbes post, “Does The Medicare Payroll Tax Still Make Sense?”

Originally published at Forbes.com on April 16, 2018.

Happy Tax Day! — or, rather, Tax Day Eve, or the day after Tax Weekend.

For some Forbes readers, it’s a day like any other, if you filed your taxes as early as possible to get your refund, or if your tax advisor is doing all of the heavy lifting. But others of you are, like me, wading through a thick pile of forms and muttering to yourself, “file your taxes on a postcard – ha!” And for some of you, two of those forms, Form 8960, for the Net Investment Income Tax, and Form 8959, for the Additional Medicare Tax, have been making your life just a little bit harder since Obamacare/the Affordable Care Act was implemented. (Yes, given the income thresholds required before those taxes come into play, those unaffected may not feel too much sympathy, or may not even be aware of them, depending readers’ degree of nerdiness about tax and health care topics, but bear with me.)

Let’s review how Medicare is funded:

Parts B (outpatient/doctors’ services) and D (drugs) are funded via a combination of funds from general federal revenues as well as premium payments, not unlike other federal programs. But Part A, hospital services, that is, the original Medicare program, is funded via payroll/FICA taxes of 1.45% for employer and employee. Originally the tax was capped in the same manner as Social Security still is, but in 1994, the ceiling was removed. Also, as part of the Affordable Care Act, in 2013, two additional taxes were instituted. For households with income over $250,000, an increase of 0.9% was added for that marginal income in the Additional Medicare Tax, for a total tax rate of 3.8%, and, in addition, for those same households, investment income was taxed at 3.8% as well.

These taxes feed into a Trust Fund, similar to the Social Security Trust Fund, and, like the Social Security Trust Fund, it’s projected to be exhausted, in this case in 2029, at which point, Medicare Part A will nominally be able to pay 88% of benefits. But unlike (or perhaps, just as with) Social Security, there is no real concern that benefit checks will be reduced by 12%, or that Medicare will pay for 88% of its usual benefits coverage. Instead it is generally presumed that the same sort of adjustments to provider reimbursements, efforts at coordination of care, and effectiveness initiatives that have been ongoing, or, failing that, another tax hike, will continue to defer this Doomsday.

For Social Security, there are reasonable grounds for a payroll tax, since benefits accrue based on wages, not on total income, and accrue to individuals, not to households. But for Medicare, there is no relationship between the amount of tax one has paid and the benefits one receives upon retirement. To be sure, as with Social Security, there are eligibility requirements; one must contribute into the system for ten years, or, alternatively, have been married to a spouse who contributed. But this effectively functions as a residency requirement to exclude comparatively recent immigrants, and, in turn, a more relaxed requirement permits the purchase of Part A benefits with five years of residency in the country. There’s no reason why a FICA tax, per se, is needed to implement these requirements.

So, to go back to the question I asked in the title of this brief column, why not fund the system through general revenues, and increase tax rates by the equivalent amount to do so? It would, after all, be a small step toward tax simplification.

There are two potential answers. One is cynical, the other pragmatic.

Readers may recall the claims that anti-Obamacare townhall protesters demanded, “Hands off my Medicare!,” for which they were mocked by Affordable Care Act supporters who deemed this proof that the government was perfectly well able to run large health care systems. More recently, Democrats/Progressives have taken their turn with this “hands off” rallying cry, in response to Republicans again raising the issue of entitlement reform. Consider these words from an opinion column from Robert Reich from this past February,

Americans pay into Social Security and Medicare throughout their entire working lives. It’s Americans’ own money they’re getting back through these programs.

Preserving Medicare funding via FICA taxes maintains the fiction that Medicare benefits are not merely a manifestation of society’s obligation to care for the elderly, but earned in an almost contractual way. It gets the job done, in terms of galvanizing public support, but it’s deceptive, because a percent-of-pay contribution for medical care inevitably means that higher earners subsidize lower earners.

On the other hand, “if it ain’t broke, don’t fix it.” As much as the public perception of Medicare may put up roadblocks for modernizing the system, the separate stream of funding may at least have the advantage of forcing attention to Medicare costs instead of leaving it ignored as just one more piece of the deficit.