FICA tax cap Archives - Jane the Actuary

February 19, 2020January 2, 2025 Jane the Actuary Retirement

Forbes post, “The Key ‘Social Security Cap’ Question: Where Are Our Priorities?”

Originally published at Forbes.com on February 19, 2020.

Here’s a recap of the leading Democratic candidates’ Social Security proposals:

“Bernie [Sanders]’s Social Security plan would lift this cap and apply the payroll tax on all income over $250,000.”

Elizabeth Warren’s “plan imposes a 14.8% Social Security contribution requirement on individual wages above $250,000 –– affecting less than the top 2% of earners –– split equally between employees and employers at 7.4% each” and “establishes a new 14.8% Social Security contribution requirement on net investment income that applies only to the top 2% ––individuals making more than $250,000 in annual income or families making more than $400,000 in annual income.”

“The Biden Plan will put the program on a path to long-term solvency by asking Americans with especially high wages to pay the same taxes on those earnings that middle-class families pay.” (No further details given.)

“Pete [Buttigieg]’s plan will [require that] . . . individual wage earnings above $250,000 (which means family wage earnings above $500,000 for equal-earning couples) will face additional Social Security taxes and earn modest Social Security benefits for their extra contributions. . . . Pete will work with Congress to develop options for enshrining a process of automatically adjusting high earners’ contributions to keep Social Security solvent without ever cutting benefits or ever sabotaging the program via privatization.”

“Senator Klobuchar supports subjecting income above $250,000 to the payroll tax and extending the solvency of Social Security.”

For each of these candidates, the additional tax would be directed both to make up projected Social Security shortfalls as well as to boost benefits, both for the poor and across-the-board.

What’s more, the Social Security 2100 Act, H.R. 860, sponsored by Rep. John Larson of Connecticut with 208 Democratic co-sponsors, but lacking the bipartisan elements that would have allowed it to become law, had a similar provision: a surtax on wage income of over $400,000. That income would earn Social Security benefits at the rate of 2% (compared to 90%/32%/15% in current law) — a rate so small as to be of no significance at all.

What’s also noteworthy about the Social Security 2011 Act is this: the $400,000 income threshold for the “excess wages” would not increase with inflation. In fact, this gap between the existing earnings limit and this “excess wages” level is intended to close, until the income level which is now a cap on both tax and accrual becomes simply a new bendpoint at which the benefit accrual drops to insignificance.

None of these five candidates’ proposals specify whether they, too, see their $250,000 threshold as a gap which closes over time, or whether they intend to preserve this gap between the ceiling and the surtax. It could be either, I suppose, bearing in mind that it’s entirely reasonable for this level of detail to be omitted from a webpage or white paper, and that these candidates’ proposals are not simply carbon copies of the Larson bill, but, at the same time, every variant of an above-cap tax that’s otherwise been proposed in detail includes a benefit accrual rate that’s so low as to be a farce and simply deceitful to claim it’s a meaningful rate.

But consider the current marginal tax rates:

A single worker earning $250,000 pays a 35% tax on income above $207,351. A married couple pays 35% tax starting at an income of $414,701. These rates increase to 37% for income above $518,401 or $622,051.

At the same time, the current FICA tax of 6.2% employee/6.2% employer is, in reality, a 12.4% tax on the workers with half of this hidden from view. The Warren proposal increases the rate paid to nearly 15%. Buttigieg’s proposal? Who knows?

And, again, the Social Security tax up to the current ceiling has some reasonable connection to benefits earned, though above the top bendpoint, this connection is already shaky. This connection between contribution rates and benefits accrued is a standard piece of the way social insurance works in most developed countries, and, in fact, the ceiling in the United States is unusual for being higher than others, not lower. A 12.4% — or 14.8% or some changeable unknown rate — rate for high earners with a farcically-small level of benefit accrual, is a tax, and nothing other than that.

So we’re left with two fundamental questions:

Should the tax rate for upper middle class earners be set at 50% of wages (plus state income tax on top)?

And if that’s the case, are we really sure that we want to spend that money wholly on boosting Social Security benefits — especially in the across-the-board manner that the various candidates are proposing — or forestalling their cuts despite increased longevity and unfavorable demographics, rather than, at least in part, meeting such needs as anti-poverty programs, childcare for low-income parents, parental leave, improved services for the disabled, and so on, or even simply reducing the deficit?

The bottom line is this: Social Security funding and spending simply must be considered alongside all other spending objectives, rather than seeing the elimination of the earnings ceiling as a source of Social Security-specific free money.

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.

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.”