Raising payroll taxes to save Social Security will cost the average worker $73,000

By James D. Agresti
January 12, 2013

To resolve Social Security’s looming financial shortfalls, one of the primary ideas being promoted is to raise taxes. Such a proposal was recently outlined in a Fox Business commentary by financial planning and retirement specialist Gail Buckner, who asserts that a “small” increase in the payroll tax rate would cover Social Security’s projected shortfalls for the next 75 years. However, a careful look at the plan’s details show that the costs would be substantial, and even with these extra taxes, the program would still be fiscally unsound.

To summarize the plan and its political implications in Buckner’s words:

I bet if you asked your friends and colleagues if they’d be willing to pay 1.3% more to shore up Social Security for the foreseeable future, the overwhelming response would be, “Is that all we need to do? I’m in!”

Of course, no politician will ever mention this. That would entail uttering the deadly phrase “raise taxes.” (It would also make Social Security less useful as a means for scaring voters.) But, really, that’s what it would take: 1.3% more- if we act today. The longer we delay, the bigger the adjustment.

In reality, this proposal would cost workers far more than she suggests. Buckner arrives at her 1.3% figure by starting with the Social Security Administration’s projection of a 2.67% long-term actuarial funding deficit. “In other words,” she says, “if we raised the payroll tax rate by this amount today, we would solve the problem.” She then slashes this figure of 2.67% in half because “employers and employees split” the payroll tax. However, that math is based upon a common misunderstanding about who bears the burden of taxes. As explained in the textbook Public Finance:

When we consider the burden of a tax, we must distinguish between the burden as it is specified in the tax law and the true economic burden. … Consider a simple example. The U.S. Social Security payroll tax requires that employers and employees split the tax, each paying one-half of the total. … But, the true economic incidence of the payroll tax is quite different. The employer has some ability to adjust the employee’s wage and pass the employer’s half of the tax on to the employee. In fact, the employee may bear the entire tax.

The Congressional Budget Office (CBO) concurs: “In the judgment of CBO and most economists, the employers’ share of payroll taxes is passed on to employees in the form of lower wages.” Likewise, the U.S. Government Accountability Office states: “While employees and employers pay equal amounts in social insurance taxes, economists generally agree that employees bear the entire burden of social insurance taxes in the form of reduced wages.” Furthermore, self-employed workers must directly pay both the employee and employer taxes.

Thus, workers would bear the full 2.67% burden of the tax, not 1.3%. This may not sound like much at first glance, but this is a percentage point increase, not a percentage increase, meaning that the current Social Security payroll tax of 12.4% would increase by 2.67 percentage points or by 21%. And because this additional tax is levied every year, it would add up to significant money. For example, under this plan, average-wage earners now entering the workforce would forfeit an additional $73,458 of their salaries to payroll taxes over the course of a 45-year career. (This is measured in 2012 dollars. Without accounting for inflation, the figure is $150,323.)

Moreover, these additional taxes may not even come close to solving Social Security’s fiscal problems. This is because the actuarial deficit of 2.67% is based upon the Social Security Administration’s intermediate projections, which are highly tenuous. Although these projections “reflect the Trustees’ best estimates of future experience,” the Trustees emphasize that “significant uncertainty” surrounds these projections. More importantly, the track record of these projections offers cause for serious concern. For example:

• In 2010, the Social Security Administration projected that the program’s trust fund would increase in real value through 2020. One year later in 2011, this projection was revised to 2018. One year after this, the projection was revised to 2012—or eight years earlier than estimated only two years prior. Hence, the trust fund in now projected to start declining in real value in 2013.

• The 2008 Trustees Report projected that Social Security would have $1.31 in income for every dollar it spent in 2011. The actual figure turned out to be $1.09.

• In 1977, President Carter signed a bill that increased Social Security payroll taxes and changed the formula governing benefit increases. At the signing ceremony, Carter said it “is never easy for a politically elected person to raise taxes,” but these changes “will guarantee that from 1980 to the year 2030, the Social Security funds will be sound.” As it turned out, the program’s trust fund continued to deteriorate until 1983 when President Reagan signed a bill that further increased taxes, raised the retirement age, and made other changes to keep the program solvent.

Perhaps more significantly, a recent paper in the journal Demography found that the Social Security Administration is using an antiquated method to project life expectancies, and as a result, the program “may be in a considerably more precarious position than officially thought.” For example, the study’s findings indicate that by 2031, Social Security Administration projections understate the cost to keep the program solvent by an average of $553 per taxpayer per year (in 2012 dollars). And this accounts for only one of many uncertainties in the government’s projections.

Hence, if politicians raise taxes to cover Social Security’s projected shortfalls, the actual shortfalls might be much greater, requiring yet more tax increases. This has been the repeated history of the program. In fact, when the program began, the federal government sent a brochure to workers stating that “the most you will ever pay” to fund Social Security is an annual tax of 6% on your first $3,000 of earnings. Accounting for inflation, this is a maximum tax of $1,741 per person. Yet in 2013, the maximum Social Security payroll tax is $14,099 or eight times the promised maximum. This does not include other taxes that are also levied to fund Social Security.

Buckner says there is “plenty of time to act” to fix Social Security because the trust fund won’t become insolvent until 2033. In addition to the fact that this date is subject to a great deal of uncertainty, the longer we wait to address the problem, the higher the cost will be. For instance, if we wait until 2033 to fix the program’s finances, the Social Security Administration projects that payroll taxes would need to increase by 32.8% to keep the program solvent, as opposed to 21% if we act now. This same principle applies to our national debt: the longer we fail to get it under control, the larger the problem becomes.

10 thoughts on “Raising payroll taxes to save Social Security will cost the average worker $73,000

  1. Right now workers stop paying into social security some where around $ 110,000.0
    I believe it would be much better to not have a cutoff point . It would be much simpler to continue paying than to increase the tax on those who are having the hardest time with incomes to begin with. There could even be a break for the lower income people. Such as not having to pay into it until after they have gone over the poverty level. While i was working i looked forward to when i reached the pay in that i would not have to pay in anymore for that year. But, If there was no cutoff point i don’t believe i would have missed it. It did not mean that i was not able to buy anything because of it. But they need to use the KISS principle , Keep,It. Simple, Stupid.

  2. Ben – Unfortunately lifting the maximum taxable wages is not likely to fix the problem. The amount of incomes above the max is small by comparisons to the incomes below that level. In view, the problems are rooted in demographics and macro economics. The first being less workers supporting more retirees who are living longer and the second being stagnant economic growth. We can tinker with the rates and the taxable base, but these solutions are not likely to work unless we address the larger issues of demographics and economic growth. Would you agree or am I mistaken in my view?

    • There are two very easy steps to “fixing” the Social Security problem FOREVER.

      1) Remove the cap.

      2) Include ALL Income… Earned and Investmt.

  3. You don’t need to raise taxes to save the Social Security Trust. A completed organization ‘assessment and turnaround’ study shows that by:
    1. Converting the Trust to a non-government/non-profit ‘retirement and healthcare’ trust owed by the contributes to Social Security and Medicare,
    2. Allow only those who pay Social Security and Medicare taxes to belong to the ‘new’ orgtanization,
    3. Replace current HMO’s with in-house HMO, and
    4. Have Government repay the $2.7 trillion, plus interest, borrowed from the Trust at a rate of $100 billion a year until debit is paid off.

    At the end of 5 years you’ll have the most financial sound retirement and healthcare organization in the U.S.

  4. The percentage of taxes doesn’t need to be raised to save Social Security. They need to raise the cap on the amount of earnings subject to Social Security. In 2012, only the first $110,100 was subject to Social Security. Anything beyond that was subject to Medicare but not Social Security. So move the cap to one million dollars.

  5. Robert Green, good ideas. Especially have the governement pay back what it borrowed. My question is, why were they allowed to do that in the first place?

  6. Below are excerpts from comments posted on Just Facts’ Facebook page, along with my responses. Some of the responses also relate to comments above.

    De M Stapp: “Social Security can be saved if the government would pay back what they have commandeered over the years calling it a loan with 1% interest.”

    Wrong. In 2011, the U.S. government paid an annual interest rate of 4.4% on the debt that it owed to the Social Security Trust Fund: http://www.justfacts.com/socialsecurity.asp#impact. Even when this money is fully repaid with interest, the Social Security Administration projects that the trust fund will be exhausted in 2033, and the program will not have enough money to pay promised benefits every year for the foreseeable future:
    http://www.justfacts.com/socialsecurity.asp#popular-looting_trust_fund

    —————————

    Buz Lawson: “Social Security’s solvency and self-sustainability is only under threat from the consistent ILLEGAL borrowing by Congress, and Congress’ stubborn refusal to repay their strong-armed loans.”

    A common myth. By law, Social Security surpluses must be loaned to the federal government, which is a requirement that was established in the original Social Security Act of 1935. The federal government is legally required to pay back this money to the Social Security program with interest, and it has never failed to do so: http://www.justfacts.com/socialsecurity.asp#popular-looting_trust_fund

    —————————

    Jose Mediavilla: “You do realize it’s just returning to the same rates that were in place from 1990-2010, right? I hardly think allowing a two-year ‘holiday’ to expire constitutes an ‘increase’.”

    Untrue. This has nothing to do with the expiration of the payroll tax holiday (this issue is not even broached in the article). As the article states, this is about increasing the current payroll tax rate of 12.4% “by 2.67 percentage points or by 21%,” which would make the tax rate approximately 15%. For reference, under the recently expired payroll tax holiday, the tax rate was 10.4%:
    http://www.justfacts.com/socialsecurity.asp#taxes-payroll

    —————————

    Jose Mediavilla: “The last time the OASDI [Social Security] rates were 4% were in the 1960s, so please stop with the grand-standing and fearmongering, and stick to the facts, as your mission statement claims: http://www.ssa.gov/oact/progdata/taxRates.html

    False on multiple accounts: The full payroll tax rate (employer and employee combined) reached a maximum of 8.4% in the 1960s, and for the self-employed, the rate was only 6.3%. For comparison, the rate for both is currently 12.4%. This is evident from the link Jose provided, but he has misconstrued it. The link leads to a table of rates that states at the top: “Rate for employees and employers, each.” This means that the reader must double the rates to obtain the full rate. The rate for the self-employed is directly stated in the table, and thus, there is no room for misinterpretation.

    —————————

    Mike Eudy: “Just raise the shut off amount to $250,000 a year from $110,000. Boom Saved for 75 years”
    Garee Peters: “just lift the cut-off threshold from $113,900 per annum….to….ALL INCOME….instant fix….forever”

    That used to be true but is not any longer. In August 2012, Social Security Trustee Charles Blahous noted that “the efficacy of tax-increase solutions is also fading with delay. Advocates on the left sometimes argue to increase the amount of Social Security wages subject to the payroll tax. The most extreme version of this proposal would be to raise the amount of wages subject to the full 12.4% payroll tax — $110,100 today – up to infinity. Yet even this drastic measure would now fail to keep Social Security in long-term balance as well.” http://mercatus.org/expert_commentary/it-becoming-too-late-fix-social-securitys-finances

    —————————

    Paula Friedman posed this reasonable question: ” ‘the average worker’ being what? The *mean* when you average in those billion-dollar-income “workers” too? ’cause the average (median) worker doesn’t even *earn* $73,000.”

    This link provided in the article specifies what is meant by the “average worker”: http://www.justfacts.com/reference/payroll_taxes_to_cover_actuarial_deficit.xls. For reference, in 2012, the “average-wage index” (as defined by the Social Security Administration) was $44,644.

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