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The Case Against Raising the Payroll Tax Cap

A new memo from the Social Security Administration actuaries shows that lifting the cap on the payroll tax, currently $88,000, would extend the life of the Trust Fund almost for the entire 75 years projected, rather than adding just seven years as the right-wing talking points would have it.

This is a good rejoinder to the conservative claim that private accounts combined with reducing benefits by shifting to price-indexing of benefits is the only way to save the program.

But it should not be taken as encouragement to propose actually raising the cap. While this is an easy fix, and seems somewhat progressive, it is in fact a bad idea. I wrote about this back in December, 2003, and have been meaning to replay that old post for some time.

I won't re-post the whole thing, because this was back before I discovered that blog posts should not be so long. (When did you discover that?, an imaginary reader asks.) But the basic argument is that the payroll tax is not a tax so much as a premium in a system of insurance. And the cap ensures that the insurance policy is basically a good deal for everyone. That's always been the bedrock of its political success. You might be able to get a better deal, in exchange for more risk, through private accounts. But no matter how you cut it, in general Social Security is a net plus for almost everyone, whether through retirement or survivors benefits. On the other hand, if you lift the cap, and people who make $120,000 are paying almost $15,000 a year in FICA taxes (including the employers' share), they would start to see it as a very bad deal. They would have to be alive and retired for almost as long as they were working in order to see a positive return.

Put another way, lift the cap, and suddenly all those "calculators" at the Cato Institute and even the real calculators start to look pretty ugly, and private accounts start to look a lot better, for a lot of influential middle- and upper-middle class people. When the privatizers come after Social Security next time, their job will be a lot easier.

Two additional points I would make now: First, this is an obvious political trap. Bush all but gave it away when he said he was open to raising the cap in Portsmouth, NH on February 15: "It's important to keep the options on the table. And it's important for me to say to the members of Congress, if you've got a good idea, bring it forward; there will be no political retribution." That's Lucy talking to Charlie Brown: Don't worry Chuck, I won't pull the football away at the last minute. Go ahead and kick it.

Of course there would be retribution. That's exactly how they were hoping to get out of this trap, by turning the tables. The minute a Democrat stepped up to propose raising the payroll tax cap, USA-Next or Club For Growth or some other group that the poor helpless White House cannot possibly control would be on TV in his district with ads denouncing him as a tax raiser, complete with a tearful testimonial from some ordinary looking person, a single parent with three kids who would pay a higher tax. And no one is exempt -- Senator Lieberman, this means you, you never-met-a-tax-you-didn't-raise big government liberal.

Unfortunately, the White House didn't send out the memo, because all their allies who were supposed to shoot at this hypothetical Democrat instead panicked and fired at the White House.

The second point is that viewed as a tax rather than an insurance premium, it's a bad tax. Lifting the cap makes it slightly more progressive, but not much. It's an ugly regressive tax that applies only to work, not to investment income. The person who gets $150,000 from his grandfather's investments would still pay nothing. We need to change the tax code to shift the balance away from labor income and back onto investment income, not further encourage the trend toward taxing work.

And it's worth remembering that this group -- those earning in the $85,000-$150,000 range actually didn't do all that well under the Bush tax cuts. The top income quintile begins at about $86,000 in household income; that top 20% got 64.5% of the total tax cuts, but those in the top 10% got 50% of the total, leaving only 14.% for everyone in that middle-upper range. That includes the dividend and capital gains cuts, so a family in that $85-120k range with income only from work would have a relatively modest tax cut. The child and other credits phase out at these levels, and the limits on itemized deductions and the Alternative Minimum Tax kick in. According to the Tax Policy Institute, taxpayers in this income range lose 47% of their tax cut to the AMT. (And yes, I realize I'm not comparing apples to apples here -- total household AGI is very different from a single worker's taxable wage base, so many workers who make $90,000 or more may be in households with incomes of $200,000 or $300,000. But this gives the rough picture of the effects.)

I'm not calling for any particular sympathy for those earning $85,000-$150,000. That's still very well off, even by my jaded, can't-afford-to-live-in-Brooklyn standards. But a much higher priority for tax policy would be to bring investment income back into the base, and go after the enormous tax cut for the top 1%. Everything's on the table, and yet none of this will pass anyway, so if we need an idea, let's make it a creative one: take back the tax cuts for the top 1% and use a small amount of general revenue to shore up the trust fund, as proposed by the Center for American Progress. (Although the CAP proposal adds a surprising feature, which is that it retains the employer portion of the payroll tax, and uncaps it, creating a straight 6.2% tax on all payrolls.) Or, get rid of the entire payroll tax, and replace it with a progressive consumption tax, as proposed by my colleagues at the New America Foundation.

But simply lifting the payroll tax cap: bad for Social Security in the long run, dangerous politics, and bad tax policy.

Posted by Mark Schmitt on March 1, 2005 | Permalink

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Comments

"it retains the employer portion of the payroll tax, and uncaps it, creating a straight 6.2% tax on all payrolls."

Oh, man. How to alienate every businessowner of any size at all in one easy swipe. You'd have to do a revenue test of some sort, I'd think.

Posted by: Linkmeister | Mar 1, 2005 5:46:24 PM

Another angle -- and I have not looked closely at how dynamically proponents and analysis have scored this effect -- is that popping the cap would motivate a lot of high-hat compensation packages to be restructured into anything but salaries -- corporate equity, deferred comp, benefits, "loans", and (aaack!) more options than ever.

IOW, a lot of the wages and salaries exposed to the payroll tax would disappear from the wages and salaries category.

Posted by: RonK, Seattle | Mar 1, 2005 5:50:56 PM

new to this blog. why lift the cap to only $150 K from the current $88 K? it's like the moment when Kerry said he was going to raise taxes on those making > $250K. the election was lost. what happened to talking about millionaires, CEO centimillionaires, billionaires? income is income. Dems shd stop talking about torturing the middle class and try to wreak some havoc with those who actually have a little disposable income.

Posted by: scorpio | Mar 1, 2005 5:59:58 PM

Ok. If this is off the table, then what's workable?

Posted by: Movie Guy | Mar 1, 2005 6:57:41 PM

"But simply lifting the payroll tax cap: bad for Social Security in the long run, dangerous politics, and bad tax policy."

It's funny. A year ago, lifting the SS cap was one of the items highest on my wish list.

But as I've learned more about the intricacies of SS over the past year, I've come around to your line of thinking.

Put progressivity into the tax system via the income tax, estate tax, and perhaps the capital gains tax - not the payroll tax.

Posted by: Petey | Mar 1, 2005 11:54:22 PM

"Ok. If this is off the table, then what's workable?"

What's workable? In the short term:

- No SS legislation in the 109th Congress!

In the long term:

- Let's wait a decade and see if the SSA's intermediate projections are as conservative as they've been in the past before we go changing SS legislation.

- Let's get a grip on the general fund annual deficit.

Posted by: Petey | Mar 2, 2005 12:08:41 AM

Well, I'd like us to return to a cap which picked up 90% of wages and salaries as was done 25 years ago. The cap, then, would be around $138-140,000.

For a family making $235,000 a year, this would be an increase of $3400:
Spouse #1 $135,000 2790
Spouse #2 100,000 620

A family making $150,000 (likely 90,000/60,000) wouldn't see any FICA increase at all.

I doubt that many Democratic voters earning over $150,000 would be lost.

Posted by: Ellen1910 | Mar 2, 2005 4:03:54 AM

How about removing the cap, but at the same time reducing the rate. Reducing the rate would help small business and low income workers. 68% of self employed and small business owners earn less than $50k and 88% earn less than $100k. I'm always amazed when the tax cut advocates claim to help small business and nobody refers to the afor mentioned facts.
Reduce the FICA rate, then remove the cap.

Posted by: phastphil | Mar 2, 2005 9:48:13 AM

phastphil -

Now THAT'S something worth investigating. Of course, the devil is in the details: will it solve the funding problem? If it does, Dems can introduce it and claim to have cut taxes. It's clear they need to bring something to the table, and this might be it.

Have you offered this solution to your Rep and Senators?

Posted by: Jon K | Mar 2, 2005 10:04:11 AM

I'm the local county Democratic Chair and a former small business owner who has been advocating this for years. Only recently has anyone listened. I've started to get some traction with Senator Wyden.

Posted by: phastphil | Mar 2, 2005 10:23:19 AM

Lower the rate and remove the cap is what Nathan Newman advocated in the track back post above. Since raising the cap is cited as a solution to the funding problem, to the degree that one lowers the rate, it would do less of that. I haven't seen the numbers on whether a cut of 2 percentage points, combined with raising the cap, would still have any positive effect on the trust fund balance.

However, Ellen1910's solution, tax 90% of earnings with no cap, has been scored and it adds ten years to the life of the Trust Fund.

RonK's comment, however, is very pertinent here -- it's easy to say, push all the increase on people earning more than $150,000 or more than $200,000, but at that point, it does create a very strong incentive to structure that compensation in some form other than wage or salary.

Posted by: Mark Schmitt | Mar 2, 2005 10:37:49 AM

Mark- Lowering the rate is the immediate policy since there is no crisis now, and I don't think Democrats should concede that for a second.

But raising the cap does help us solve any future problems, since if they arise we can always reraise the rate to present levels again.

On the other hand, raising the cap only to include the bottom 90% of wages seems bizarre. The political problem you raise is alienating the moderately well-off upper-middle class, but we should have no political qualms about going after the wages of the very wealthy, especially since there is so much income to help defray a larger payroll tax cut.

Posted by: Nathan Newman | Mar 2, 2005 11:58:18 AM

Raising the cap to include 90% of wages and salaries is, of course, merely a wonk's exercise (it's not going to happen under Bush/Delay, and there's nothing Democrats should be willing to give up to seek to induce that pair to agree to it).

The proposal, however, should not be rejected on the grounds that it does not wholly fix the "projected" program shortfall -- assuming any of us is confident that a shortfall computed over 75 years is knowable.

As upper income wage earners (the 20% Reich named symbolic analysts) pull farther and farther ahead of the other 80%, its members' SS exemption will continue to grow as will its disinterest in maintaining SS.

Raising the cap is a political issue more than it is a wonky financial fix.

Posted by: Ellen1910 | Mar 2, 2005 12:44:27 PM

the other issue is seperating Social Security funds from the General Fund. This would be part of the requirement if the cap is removed the rate is reduced. The reason I propose reducing the rate come from the personal experience of calculating my employees payroll. Reducing the rate would be the opposite of trickle down. I'm with
Tom Harkin, how about perculate up! FICA is simply too regressive.

Posted by: phastphil | Mar 2, 2005 1:43:02 PM

werd up, mark. tax the unearned wealth. let the billionaires work for their money for a change.

but i'm not opposed to getting rid of the cap and applying a progressive income tax. that alone would lower the rate signficantly for most people. but the problem with that as you mention is that SS payroll taxes are thought of not as a tax but as a premium for an insurance program that people are buying into. and everybody says that's one the reasons for the program's political success.

But I dunno. I think it might be possible to convince the public that it is indeed a tax and that as such the wealthy need to pay their fair share of the burden, which would be at the very least an equal but preferably higher taxrate. especially when you explain to someone very simply that this would result in a lower taxrate for most people.

But definitely. tax the unearned incomes. I'm not hearing enough of that these days.

Posted by: Phil | Mar 3, 2005 9:27:18 AM

Big Picture, I don't favor the payroll tax. Retain and reaffirm the generational contract, but fund it, pay-as-you-go, out of general progressive revenues (and general debt capacity). Retain the structured credit for lifetime wage earnings.

An Ellen1910 hints, labor markets are acting less and less like markets, more and more like franchises. Franchise-holders are price-setters who profit in the large by purchasing ordinary labor "below market". This will deflate payroll tax revenues over teh decades, and that's your real looming crisis in the current funding scheme. [The boomer "pig in the python" problem is probably a figment of bad math.]

This is also your moral/market justification for social distribution under a progressive tax.

And that runs smack into one of the Big Questions of the global century: "Can you tax the rich?" Will they just move? (Kudlow) Will they retaliate? (Folk wisdom) Will they out-label and out-loophole the commoners? (Hill wisdom)

A savvier polity could take this on. Current world, we're mostly just going along for a ride in a handbasket.

Posted by: RonK, Seattle | Mar 3, 2005 1:38:17 PM

It makes philosophical and moral sense to scrap payroll tax revenues for something more progressive, such as general revenues. The question is: how to get from here to there? One possibility (implied in observations made by Jon Forman and others, I believe) is that if we do nothing during the next 30+ years to "fix" Social Security, the "Trust Fund" may come so close to exhaustion that Congress will be compelled by reality to start pouring in some general revenue funds. Once that precedent is established, continued public demand for the preservation of benefits may make conversion to a system at least partially funded by general revenues an inevitability. To slightly modify an old saying, "If it ain't broke yet, don't fix it."

Posted by: Fred Moolten | Apr 12, 2005 2:01:19 PM

Well said!

Posted by: ceritto | Aug 17, 2005 7:26:31 AM

I'm not hearing enough of that these days.

Posted by: frollo | Aug 17, 2005 8:29:58 AM