Reader Requests: How Does This Taxable Wage Cap Work, Exactly?

A reader asks: You recommend raising the taxable wage cap. What would be the effect on the maximum benefit? Could the benefit be frozen?

The taxable earnings base is a cap on both taxes and benefits. Therefore, if we remove the the cap, both taxes and benefits would increase (but only for people earning more than $106,800). According to the Congressional Research Service, this change would eliminate 95 percent of the projected 75-year shortfall in the Social Security Trust Fund.

Yes, we can “freeze” the benefit. We can keep the cap on benefits but eliminate it on taxes, resulting in a tax increase for people earning more than $106,800 with no compensating increase in their benefits. According to the CRS, this change would eliminate 115 percent of the projected 75-year shortfall.  

The latter option is tempting if you earn less than $106,800, but it’s politically impossible because it turns Social Security into a vehicle for income redistribution.

It’s also not necessary. Eliminating 95 percent of the shortfall is more than sufficient. We’re dealing with highly uncertain projections. The shortfall may be less than we expect. Even if it’s not, 5 percent of the Social Security shortfall is small compared to the rest of our budgetary problems. We can discuss more radical changes if and when they become necessary.

For now, eliminating the taxable earnings base on both taxes and benefits would be a quantum leap in the right direction.

Another reader asks: Is it not curious indeed that Social Security benefits have an automatic COLA increase, however the funding mechanism payroll taxes do not have a commensurate funding increase mechanism by increasing the cap on non-exempt wages subject to the tax?

Actually, the taxable earnings base does increase over time. “Because the cap was indexed to the average growth in wages,” according to the CRS, “the share of the population below the cap has remained relatively stable at roughly 94%.”

However, because the top 6 percent (and especially the top 1 percent) has experienced so much more income growth than the rest of the population in the past thirty years, the percentage of covered earnings decreased from 90 percent in 1982 to 85 percent in 2005.

Unfortunately, raising the taxable earnings base back to 90 percent of earnings only eliminates 43 percent of the 75-year shortfall.

Besides, the cap never should have existed in the first place due to its unfair regressiveness. If the people earning $20,000 have to pay payroll taxes on all of their income, so should the people earning $500,000.