No Simple Solution to the Social Security Deficit - Raising the Wage Cap on Payroll Taxes Is Not the Quick Fix

Nothing is as easy as it seems. If life were easy, we could solve the financing gaps in Social Security in five simple words – eliminate the cap, problem solved.

Life isn't easy

In the words of H.L. Mencken, for every complex problem, there is an answer that is clear, simple, and wrong. Nothing is that easy. Eliminating the cap does not solve the problem. It does not officially even kick the can anymore. According to the Congressional Budget Office and the Social Security Administration, this policy option addresses about 40 to 70 percent of the shortfall.

What is the wage cap?

Currently, payroll taxes of 12.4 percent apply to the first $127,200 of a worker's annual wages. When a worker earns his 127,201st to infinity dollar, there is no tax.

Does limiting the range of payroll taxes make sense?

No one can really say whether the concept is achieving its aim, because no one really knows why the limit was incorporated in the original legislation. Since its enactment, this aspect of the program evolved on autopilot into a mechanism to pay the bills. At this point, the maximum amount subject to payroll taxes rises faster than inflation.

Social Security is intentionally progressive

In the original design of the system, the crafters planned for those with means to pay more for benefits than less-affluent workers do. That feature hasn't changed to this day. On the last $1,000 of wages, everyone pays the same amount of taxes. Yet, the formula gives the lower-wage worker a monthly bump in benefits that is nearly six times larger than the increase given the person who is working for the full taxable amount.

Unfortunately, the program has changed so much that these higher-paid workers not only pay more for benefits, but also likely lose money in the process. That was not the intention of the founders. FDR did not want the program to be confused with a public dole because he feared that would put the elderly at the mercy of the politicians. FDR did not want a "damn politician" (his words) like Senator Bernie Sanders or Governor Chris Christie to judge who does and who does not need benefits.

At this point, the threshold serves to close out the program's incremental progressivity, a circuit breaker preventing the system from becoming overly dependent on subsidies from the rich. The problem is that no one can tell you where that circuit breaker needs to be.

A programmatic dichotomy: welfare or insurance?

The reason that we find little consensus on changing the amount of earnings subject to payroll taxes derives from the fundamental ambiguity in perceptions of the system, either as a form of welfare or a form of insurance. People who see the program as welfare assistance see no reason that those most able to pay for the bills should be excused from carrying the cost. On the other end of the spectrum, you find people who want the program to be insurance that is independent of the politics of the day.

If Social Security is insurance, it is no more reasonable to ask the rich to pay ever-higher premiums than it is to ask them to pay more for bread, a car, or movie tickets. How would you like to go to the movie theater and be told that the price of the ticket would depend upon how much you make?

Complicating the deficit picture

Typically, we look at policy for Social Security as though it operates in a vacuum. The fact is that it doesn't. These changes would trigger secondary actions within the broader economy that would exacerbate the nation's deficit, and increase the overall level of debt owed by the country.

While Social Security is not "counted" toward the nation's deficit, that truth does not mean that the program does not contribute to the gap in our nation's financing. Most economists believe that payroll taxes are offset by lower wages on a dollar-for-dollar basis. Lower wages reduce the income tax revenue collected. If we increase the payroll tax on wealthier workers, the corresponding reduction in wages will translate into large reductions in income tax collection.

Economists call this process behavioral response. In terms of higher taxes on wages, employers respond by slowing wage growth and employees shift compensation to things like stock options or health benefits, which lie outside of the scope of payroll taxes. To illustrate the progression, the Social Security cap in 1984 covered about 90 percent of wages. Today it is around 84 percent. It is simple. Wages subject to a 12.4 percent tax will grow more slowly than wages without such a constraint.

Conversation stopper

The policy option today serves as a discussion plug, ending the exchange on how we can fix Social Security. A large audience sees the crisis forming, but believes that raising the taxes on someone else will end the problem. They join the conservation just long enough to say: eliminate the cap, problem solved.

This answer doesn't solve the problem, and will draw Social Security further into the spotlight of budget negotiations. In total, it largely fixes our headache by giving our children a bigger one.

Nothing is easy.

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This article was provided by our partners at moneytips.com.

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