The wealthy are a hot topic in Washington right now.
President Joe Biden recently proposed a so-called billionaire minimum income tax in his 2023 annual budget, which would increase levies on the country’s wealthiest households.
Individuals with a net worth of $100 million or more would face a 20% tax on their total income, including unrealized appreciation, under the plan.
However, one other proposal circulating on Capitol Hill — raising taxes on high earners earning $400,000 or more a year — was omitted from Biden’s budget, despite the fact that it could help solve Social Security’s funding problems.
Social Security is funded by payroll taxes, which will be levied on wages up to $147,000 in 2022. Employers and employees both contribute 6.2 percent of wages up to the annual income threshold.
A recent Congressional proposal seeks to strengthen the program by imposing the payroll tax on wages of $400,000 and above, among other changes.
Legislators’ time is running out to make necessary changes to ensure the program can continue to pay benefits as promised. According to the Social Security Board of Trustees, the funds could run out in 2034, at which point 78 percent of benefits will be payable.
To bolster the system, policymakers must choose between reducing benefits through changes such as raising the retirement age, increasing taxes, or a combination of the two.
Applying Social Security payroll taxes to those earning more than the wage base is a popular idea, with its own campaign slogan, “Scrap the Cap,” according to Nancy Altman, president of Social Security Works.
Once a worker earns more than $147,000 per year and is no longer required to pay Social Security taxes on that amount, their paychecks are no longer subject to those levies.
As a result, workers earning more than the earnings threshold may be required to pay Social Security payroll taxes for only a portion of the year.
“Many people are unaware that there is a cap, and when they do, they believe the law should be changed to require everyone to pay in throughout the year,” Altman explained.
Wages are also subject to a 1.45% Medicare tax. When combined with Social Security, this amounts to a 7.65% tax on both employees and employers. This is referred to as FICA, which stands for Federal Insurance Contributions Act.
Notably, there is no wage cap on the Medicare tax, as Congress abolished it in 1994.
Today, legislators have the option of making the same change to Social Security. Additionally, they could choose to increase the tax rate from 6.2 percent to 6.2 percent.
What modifications could be made?
Democrats have proposed reinstituting the Social Security payroll tax on wages exceeding $400,000 per year. Earnings up to $147,000 would continue to be subject to taxation. Then there would be a donut hole or gap in which taxes would not be assessed until wages exceeded $400,000, at which point the tax would be assessed again.
According to Kathleen Romig, director of Social Security and disability policy at the Center on Budget and Policy Priorities, there are additional ways for lawmakers to increase the Social Security payroll tax.
This could be accomplished by simply applying the tax to all wages exceeding $147,000.
Additionally, they could impose a surtax on high earners, potentially reducing their benefits.
Additionally, lawmakers could choose to apply Social Security payroll taxes to programs that did not exist when Congress addressed this issue previously, such as transit subsidies or flexible spending accounts.
Since the cap was established, wages at the top have grown at a much faster rate.
Initially, Social Security payroll taxes covered approximately 90% of wages. According to a 2016 estimate, the cap would need to be around $270,000 to cover that level of wages.
“Simply maintaining current levels of wage inequality in this country, let alone other forms of inequality, would close a significant portion of the financing gap,” Romig said.
Changes will become increasingly costly over time
The longer Congress delays acting, the less likely it is that increasing the taxable wage base alone will solve Social Security’s overall funding problems.
Eliminating the cap was once sufficient to eliminate the deficit, according to Joe Elsasser, founder and president of Covisum, a company that develops software for Social Security claimants.
Even if all wages were taxed, he said, it would only cover 60% to 70% of the shortfall.
“With each year that we delay reforms, the cost of maintaining current worker tax revenue indefinitely increases,” Elsasser said.
How to invest wisely in retirement in 2022
Raising the taxes that workers must pay, he said, raises concerns about intergenerational equity.
“Is it fair to force the next generation to support their parents, which is effectively what happens when payroll taxes are increased to fund retiree benefits?” As Elsasser stated.
If the payroll tax rate is increased above 6.2 percent, workers will see a decrease in take-home pay.
“From an individual planning standpoint, the challenge is to avoid letting it eat into your own retirement savings,” Elsasser said.