As part of the deal to end the government shutdown, the House and Senate are now working together to come up with a joint budget — Medicare and Social Security are sure to be part of that discussion. Many progressives argue that benefits paid for by Americans throughout their whole working lives should not change, either by modifying cost-of-living increases, cutting benefits or raising the retirement age (which wouldn’t actually do much good for the budget).
However, there may be a way to ensure these programs have the funds to continue paying future beneficiaries without taking anything away from current retirees.
Anyone who earns a paycheck knows the Federal Insurance Contributions Act, or FICA tax, is deducted to pay for Social Security and Medicare. In 2013, 7.65 percent of your paycheck will go to those two programs (6.2 percent to Social Security, and the rest to Medicare). Businesses must also pay the same amount for each employee.
But these payroll taxes apply only to earnings of up to $113,700 a year, which is this year’s cap (it rises from year to year). Any earnings above that are not subject to FICA taxes. If you earn $227,400 in 2013, for example, you would only pay FICA taxes on half of that.
The median income in the United States in 2012 was just over $51,000, according to the Census Bureau. This means that more than half of Americans already pay FICA taxes on all of their income.
Raising or eliminating the payroll tax cap would not alter most paychecks at all—as few as 5 percent of Americans would pay more. Since most employees would see no change, employers would not have to pay much more either.
Raise It To Save It
According to the program’s trustees, Social Security’s trust funds will be exhausted in 2033, and Medicare’s in 2026. Some action is needed to prevent this from occurring—the question is what.
The idea of eliminating the cap isn’t new. The Congressional Research Service estimated subjecting all earnings to payroll taxes would keep Social Security solvent for another seventy-five years.
Still, it’s a difficult sell. After all, any tax increase is politically difficult. Luckily, the plan can be retooled to appeal to policymakers and even benefit most Americans.
Eliminate The Cap . . .
For starters, the payroll tax cap should be repealed, making all income subject to FICA taxes. The downside, apart from some wealthier Americans having to pay more, would be that some businesses with higher-paid employees could also see their burdens rise, since employer contributions match those of employees.
That’s where the second part of the plan comes in.
. . . Then Cut The Rate
Before this year, the United States implemented a payroll tax “holiday,” cutting the Social Security rate for employees to 4.2 percent from its usual 6.2 percent. (Businesses did not see a rate cut.) The Tax Policy Center found that households earned, on average, an extra $900 to $1,000 a year because of that cut. Unfortunately, it expired this year, curbing consumer spending.
To win support for eliminating the cap, policymakers could include a second, temporary payroll tax cut. To sweeten the deal, businesses could also receive a temporary rate cut, allowing those with highly paid employees to keep their payments lower for a few years.
It’s worth noting that cutting the Social Security rate to 4.2 percent would not only benefit the 95 percent of Americans who already pay FICA taxes on all of their income, but also many Americans who would have to pay taxes on more income.
For example, someone earning $150,000 a year will now pay $8,698.05 in FICA taxes on their first $113,700 of income. Paying 5.65 percent on all $150,000 would cut that bill to $8,475. If businesses saw a rate cut as well, expenses would decrease, allowing business owners to invest or bring on more workers.
Additionally, a proposed rate cut would have to be phased out eventually, otherwise benefits of this plan would be much smaller than anticipated. However, there is a simple fix: a half-percent increase each year for four years allows Americans to adapt.
The vast majority of Americans would still see a net tax cut over those four years and be no worse off afterward. Businesses without higher-paid workers would be unaffected, and could receive a temporary cut. Consumer spending would rise, boosting the economy.
Best of all, Social Security and Medicare would have the revenue needed for future beneficiaries.