How you would fix Social Security: Tax higher earnings?

imrs.phpAbout a month ago, the Post invited readers to chime in on what they thought were the best ways to fix Social Security

With the help of the Center for Retirement Research, we presented an array of 12 solutions commonly suggested for the retirement system, which is projected to be so depleted that it will be unable to pay full benefits by 2033.  Then we asked readers to pick the options they would consider.
This week we’re reporting on the solutions that have resonated with the most readers. We’re tallying the results we’ve seen so far, but you can still check out the graphic and choose the solutions you think would work best. 

If you make more, you should pay more.

The most popular solution, chosen in 71 percent of the nearly 3,600 votes submitted as of last week, was a proposal to gradually raise the amount of earnings on which Social Security taxes must be paid over 10 years until 90 percent of all earnings are covered. Today only an estimated 82.5 percent of all earnings are covered.

The difference? This year, a worker stops having to pay Social Security tax on any earnings beyond $117,000. For some workers, that means a bump in take-home pay each paycheck after. But if 90 percent of all earnings were covered and taxed by Social Security, the earnings cap would be $250,200, based on the intermediate assumptions of the 2014 Social Security Trustees Report. Even though plans to raise the cap would also include increasing benefits for higher earners, this change would still erase 20 percent of Social Security’s projected shortfall in 2033, the year in which it would no longer be able to pay full benefits.

This change would touch very few workers, so maybe it’s no surprise it was the most frequently chosen solution in a survey that allowed readers to choose more than one solution. The Social Security Administration estimates that only 5.7 percent of all workers will exceed the cap this year. Many of the 94.3 percent of workers who pay the tax on every dollar they earn don’t even realize there is an earnings cap.

But interest in increasing the earnings cap also underlines an important reason that Social Security is vulnerable to running out of enough money to pay full benefits. Although the increase in life expectancy and the retirement of the baby boom are often fingered as the culprits, “more of the shortfall is caused by slow and unequal wage gains,” said Monique Morrissey of the Economic Policy Institute.

Even way back in 1983, the last time steps were taken to keep Social Security on a solid footing and when the oldest baby boomers were a mere 37,  folks involved in fixing Social Security could foresee the baby boom’s eventual retirement and forecast that there would be fewer workers paying taxes per retiree receiving Social Security benefits, Morrissey said.

“The estimate of the future relationship between beneficiaries and workers was just about the same in 1983,when the program was last in balance,” according to a report by the 1994-1996 Advisory Council on Social Security. “In other words, the fundamental ratio of beneficiaries to workers was fully taken into account in the 1983 financing provisions and, as a matter of fact, was known and taken into account well before that.”

But there was an unforeseen change in the economic landscape that has led to less money than expected flowing into Social Security; a slowdown in the average wage index, which is used to calculate increases in  the Social Security earnings cap. Adjusting the cap based on that index was expected to help prevent erosion in the percentage of earnings taxed, which had been 92 percent at the beginning of the program in 1937 and, after amendments to the Social Security Act in 1977 reached 90 percent in 1983.

But it didn’t work because wage growth slowed. In the five years leading up to 1983, the average annual wage increase as calculated by Social Security was 8.256 percent. In the five years from 2009 to 2013, the average was 1.676 percent. Certainly the Great Recession had something to do with the slowdown–the average wage index went down by 1.51 percent in 2009, the year the recession hit bottom.

But the slowdown in wages also reflects the growth in income inequality in the U.S. because the earnings of the most highly paid workers have grown faster than average earnings.

The Federal Reserve Board’s Survey of Consumer Finance released in September found that the top 3 percent of families accounted for 30.5 percent of income in 2013, down slightly from a pre-recession high of 31.4 percent in 2007 but up substantially from about 25 percent in 1989. The bottom 90 percent of families’ share of income fell to 52.7 percent while the share of income for the 7 percent of families in the top 10 percent of earners but not in the top 3 percent, stayed at about 17 percent. The data “confirm that the shares of income and wealth held by affluent families are at modern historically high levels,” according to the study. It also notes that “the gains in income and wealth shares have been concentrated among the top few percentiles of the distribution.”

In other words, the very rich are getting very much richer with a relatively small percentage of their earnings subject to Social Security taxes. For instance, someone with $500,000 in annual earnings would be out from under today’s $117,000 earnings cap in about three months.

Since benefits are based on earnings, raising the earnings cap would mean that better-off recipients would also have their benefits increased, although not in proportion to their increased taxes. That is because Social Security benefits are structured to replace more of the earnings of the lowest earning recipients and a smaller percent of the income of top earners.

But raising the cap “would constitute a massive tax increase on high earners, effectively adding 12 percentage points to the top tax rate,” argues Andrew G. Biggs, resident scholar at the American Enterprise Institute.

Biggs said that after all new tax rates and the elimination of exemptions are included, the top marginal tax rate is about 43 percent today. Eliminating the cap for Social Security “would raise that top rate into the 60s, and adding state income taxes could leave many high earners paying 70 percent” in taxes on the highest portion of their earnings.

“Most European countries have long since abandoned such high tax rates,” said Biggs. “It would be ironic and economically damaging if the U.S. replicated them.”

Still, other surveys also have found support for raising the cap. A National Academy of Social Insurance survey released in January, 2013 found that 7 out of 10 surveyed backed a combination of changes including raising the earnings cap gradually over 10 years until the wage cap disappeared entirely.

On the other hand, Biggs noted that President Franklin Roosevelt’s original design for Social Security didn’t include the wealthy as participants, either as tax payers or recipients. But the exemption for the wealthy was eliminated when the program was implemented, Biggs said, “to differentiate Social Security from a welfare program. That’s been a key to the political support for the program: there’s a strong perception that people have paid for the benefits they’re receiving, versus a welfare plan where one group pays and a different group receives.

“Eliminating the payroll tax ceiling would alter Social Security in a pretty fundamental way, such that high earners wouldn’t feel the same stake in preserving the program,” he said.

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