This is the second installment in a series of articles addressing the future of Social Security.
In my previous post, I outlined the problems our Social Security system is facing. In this article, I will examine the benefits and challenges of one proposed solution: raising taxes.
Social Security is financed primarily through a pay-as-you-go system. Every American worker pays social security taxes. Current law requires employers to withhold the tax from employees’ paychecks. These funds are then transferred to retirees.
According to the Internal Revenue Service (IRS), the current withholding rate is 6.2 percent for the employer and 6.2 percent for the employee, leading to a total of 12.4 percent. This is notably higher than the one percent payroll tax instituted in 1937 during the early stages of the program’s implementation. Similarly, the cap on maximum taxable earnings has increased from $3,000 (equivalent to $53,000 today) to $127,200.
Tax increases are one way to improve the fiscal health of our national retirement system without reducing benefits for current or future retirees. Several think tanks and policymakers have advanced the idea of increasing payroll taxes to stabilize Social Security.
The Center on Budget and Policy Priorities (CBPP), a nonpartisan research institute, used estimates from the Social Security Administration to summarize the effects of potential payroll tax increases. They found that raising or eliminating the cap on the highest earners could help, but the effect would be limited because only six percent of workers earn above the current cap.
To ensure the viability of the program for another 75 years, payroll taxes would need to increase by 1.29 percent points for both workers and employers, pushing the total payroll tax to nearly 15 percent. Furthermore, the longer the problem goes unaddressed, the higher the tax increase needs to be. If nothing is done until 2034, taxes will need to be raised by 2.29 percentage points for employers and employees, bringing the total payroll tax to nearly 17 percent.
Although these may seem like minor adjustments, raising payroll taxes would have long-term consequences on the federal budget and, more importantly, the national debt.
A country’s debt is inherently backed by the taxing authority of its government. The U.S. government owes over $21 trillion (and counting). While increasing payroll taxes could reduce deficit spending related to entitlement programs like Social Security, it would not address the debt that has already been incurred. This would effectively amount to a lien on the income of future workers.
Additionally, research shows that employees pay most of the employer’s share of the payroll tax in the form of lower wages. A tax hike here could increase negative wage pressure and slow wage growth.
Tax hikes can go a long way toward addressing the problems facing Social Security. However, there are serious tradeoffs to addressing this issue with tax hikes alone. The history of the program suggests tax hikes may only buy time as the earnings of future generations are committed to even higher taxes.
We owe it to future Americans to get this right. Fortunately, our policy toolbox is not restricted to raising taxes. In my next post, I will discuss another commonly proposed solution: reducing benefits.
Meet the Author
Raheem Williams is a research specialist for the Center for the Study of Public Choice and Private Enterprise (PCPE). He is also the founder of The Policy, a public policy forum with an emphasis on empirical analysis. Read his bio.