Philip Moeller

Philip Moeller

Social Security payroll taxes are a major expense for employers and employees alike. Each party now must pay 7.65 percent on the first $117,000 of covered wage earnings, with that amount split between Social Security (6.2 percent) and Medicare (1.45 percent, with the proceeds going to the Medicare trust fund that pays for hospital expenses under Part A of the program).

These taxes are nearly universal in private workplaces and, increasingly, in government jobs as well. It’s easy to see them as an immutable cost of business, which over time becomes a forgotten fixed cost. The same is true for employees, especially younger ones.

But in an aging nation, the importance of retirement in general and Social Security in particular will only grow. And if employers looked at the program with fresh eyes, they might be able to fashion better benefit programs and strengthen relationships with their employees in the process. Here’s a quick primer on Social Security and a look at the impact of changing payroll taxes.

Social Security reform has been just around the corner for years. The last major reforms in the program were enacted in 1983 by the Greenspan commission, headed by economist Alan Greenspan, who would later chair the Federal Reserve Board for nearly 20 years. Creating an authoritative commission was necessary because even 30 years ago, Congress could not muster the consensus to make changes in the program. Today, of course, Congress has trouble mustering a consensus that today is even today.

But cracks in the program’s finances have been evident for a long time. Changes billed as ensuring solvency for 75 years, it turns out, will endure for fewer than 50. The program did build up big surpluses but they are now being spent down, with benefits exceeding revenues at an accelerating pace.

The overall fund for OASDI (Old Age Security and Disability Insurance) is split into separate OAS and DI funds. The latter is in especially bad shape and will run out of money in about two years.

Congress could authorize that more money be siphoned into the DI fund from the much larger OAS fund. This has happened once before, and allowed Congress to defer broader reforms. Doing so again is possible but the time for fixing broader issues without causing major problems with people’s retirement plans has run out.

Common wisdom, while perhaps an oxymoron inside the Washington beltway, holds that people aged about 55 and older should be spared from any major negative changes in Social Security. They are close enough to retirement that they do not have enough time in their careers to adjust to any Social Security cuts.

With OASDI projected to be unable to pay all its scheduled benefits in only 15-16 years, the need for a 10-year lead time means that the program’s cushion will get much, much smaller before reforms begin to reduce annual deficits.

The menu of possible reforms includes extending the retirement age, reducing annual cost of living adjustments, means-testing benefits for high earners and other benefits tweaks. But there is no way to come close to balancing Social Security without changing payroll taxes.

While it’s called a payroll tax, Social Security taxes are not regarded the same way as income or sales taxes. Generally, people feel like their payroll taxes are a fair price to pay for their future Social Security benefits. Last year, the National Academy of Social Insurance found that people were willing to pay more in payroll taxes to preserve the program.

“Eighty-two percent of those surveyed agreed that it is critical to preserve Social Security for future generations even if it means increasing Social Security taxes paid by working Americans,” says Elisa A. Walker, a NASI policy analyst. “Responses were remarkably constant across political parties, age, income, and race/ethnicity. For example, those who agreed it is critical to preserve Social Security for future generations even if it means increasing Social Security taxes for working Americans include 74 percent of Republicans, 88 percent of Democrats, and 83 percent of independents.”

There are two major ways to boost payroll taxes: 1) raise the wage ceiling on which taxes are owed, and, 2) raise the percentage rate of the payroll tax. The impact of both were laid out in a recent report from the Congressional Budget Office.

Historically, 90 percent of wages were captured by payroll taxes. In recent years, wages have stagnated for the middle class but continued rising for higher earners. Today, as a result, only about 83 percent of wage income falls at or beneath the ceiling, which is $117,000 this year and rises each year by the rate of consumer price inflation.

Raising the ceiling back to 90 percent would be a logical first step toward boosting program revenues. If this were done (and it would need to be phased in over years), the wage ceiling would more than double, the CBO said. If the change were made all at once, the ceiling in 2015 would be $241,600. People earning between the current and new ceilings would get a boost in their eventual Social Security benefits in exchange for their higher taxes. But it would be a very modest boost. Social Security has a very progressive benefit formula that credits a high percentage of lower-earners’ wages but a very small percentage of high-end wages.

This increase would, by itself, close 30 percent of the program’s projected financial shortfall during the 75-year window from 2014 to 2089 (program solvency projections are based on a 75-year time span). Some people would like to load even more of the financial burden on wealthier earners.

Eliminating the ceiling and making all wages subject to the payroll tax would close 45 percent of the projected shortfall, the CBO estimated. And if higher Social Security benefits for high earners were limited more than under current law, it would be possible to eliminate nearly two-thirds of the system’s financial problems solely on the backs of the wealthy. For many reasons, I oppose this.

Increasing the OASDI part of the payroll tax to 7.2 percent from 6.2 percent (for both employee and employer shares) would close 60 percent of Social Security’s 75-year financial shortfall, the CBO projected. So if this were done and the annual tax ceiling were increased to capture 90 percent of wage earnings, 90 percent of the shortfall would be addressed.

Of course, solving Social Security’s problems is much easier on paper than in reality. Conservatives tend to oppose any tax increases and often seem especially against higher taxes for the wealthy. Liberals recently have rallied to the notion that Social Security reform must include higher revenues that would fund more benefits for lower-income earners.


Philip Moeller
Contributing WriterMoney
Authorbook on Social Security, under contract with Simon & Schuster
Speakeron retirement and successful aging
Journalist and EditorAmerican History of Business Journalism
Research FellowSloan Center on Aging & Work, Boston College