Reasons Not to Raise the Social Security Cap

By on August 25, 2014 in Current Events with 98 Comments

Almost any article in the media about Social Security is almost assured to generate a five word response: Raise the cap, problem solved. While the idea of exposing all wages to payroll taxes is one of the more popular policy options in the Social Security debate, it is bad policy that will only serve to further destabilize the system over time.

Before I explain why removing the cap is a bad idea, let me explain how the cap works. Today, Social Security collects revenue from a wage tax, or FICA (Federal Insurance Contributions Act). It is applied to people who work in jobs covered by Social Security. FICA is a fixed rate (12.4% currently) on their wages up to a limit ($117,000 currently). The “cap” limits how much any one individual will pay in FICA over the course of the year.

People look at these payments in two opposing ways. Some see FICA as a tax. Some see it as an insurance premium. The nature of FICA is important because how you look at these payments leads to completely opposite conclusions about how to fix Social Security.

Eliminating the cap solves 45% of the 75 year financing gap
CBO July 2014

While FICA is constitutionally collected under the power to tax, it is very difficult to classify FICA as a tax because every dollar in creates a promise of money in the future. When a worker pays $1 today and gets a promise of roughly $0.90 cents in future benefits, it is hardly a $1 of tax. (SSA’s projections on the worth of $1 of FICA taxes). For simplicity’s sake, let’s agree that any part of FICA which doesn’t generate an expected return is a tax.

If you see FICA payments purely as a tax, any limit on the tax makes no sense. If we are going to pay for Social Security with a tax, all Americans including retirees should be subject to the tax. The tax base should extend beyond wages to all forms of income. The system should also tax all workers, including those of Galveston County who were exempted from Social Security 30 years ago. It is unreasonable to narrowly focus a regressive tax on a sub-set of workers. (Roughly 7% of the work force is not covered by Social Security).

On the other hand, people who see FICA payments as an insurance contribution do not want the system to depend upon tax revenue at all. The reasoning is simple. Tax revenue is a political priority. Once benefits are derived from tax revenue, the level of benefits will be a constant political battle in which voters weigh the value of Social Security against other priorities, say student loan reform.

As a tax, Social Security revenue is subject to political priorities, even within the Social Security program. Within the group of raise-the-cap supporters, there is a divide between those that would use the new found money to provide support for future retirees, and those who want to use the money to increase benefit levels of current retirees. Senator Bernie Sanders claims to support both.

FDR specifically designed the system so that Social Security would enjoy an exemption from political priorities. He said, “We put those pay roll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program.” FDR understood that if person A pays for person B’s benefits, there would be an eternal political struggle between person A who feels that he pays too much and person B who knows that he is paid too little.

Social Security is where it is today largely because Congress abandoned FDR’s vision. In the original design, a worker’s contribution would pay for benefits to the retirees of his generation. Congress changed the system so that a worker’s contribution pays for the retirement benefits of retirees from another generation (we call Pay-As-You-Go). Ever since, we have been in a political struggle over benefit levels between retirees who feel the benefits are too low and workers who cannot afford the cost.

If we removed the cap on payroll taxes, the incremental revenue would be almost entirely tax revenue. The benefit formula slows the growth of benefits as wages rise. So removing the cap will generate lots of revenue on which the worker earns little benefit. Flushing tax revenue into the Social Security system will only further erode the link between contribution and benefit on which the system depends for independence.

To someone who is 65, any tax solution should be alarming. At that point in your life, you expect to live roughly 20 years. You would like to retire, but you have no way to gauge how the politics of benefits will change over the rest of your life. Social Security serves an audience, the elderly and disabled, which is not in a position to adapt to uncertainty.

Social Security as an insurance premium is very easy to justify. It is simple to justify giving the most to people who contribute the most. The system is much more difficult to justify as a tax redistribution program. It is difficult to justify using tax revenue for a system which rewards those with the highest past earnings. It is virtually impossible to justify using tax revenue for a system which excludes millions of Americans regardless of need. It is impossible to justify taking money from people who are in poverty to subsidize those who aren’t.

Eliminating the cap on taxable wages does not fix Social Security. This policy option ends Social Security, and replaces it with a system which does not have a stable source of revenue nor an efficient way to distribute benefits. We are the damn politicians that FDR feared.

© 2016 Brenton Smith. All rights reserved. This article may not be reproduced without express written consent from Brenton Smith.

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About the Author

Brenton Smith (A.K.A. Joe The Economist) is the founder of “Fix Social Security Now” which provides information on all alternatives in the public debate on Social Security through its site www.FixSSNow.Org.

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