Removing the Social Security earnings cap virtually eliminates funding gap

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Snapshot for February 17, 2005

Removing the Social Security earnings cap virtually eliminates funding gap
Using relatively pessimistic assumptions about future growth in productivity and immigration, the Social Security Administration (SSA) actuaries estimate that Social Security trust fund revenues will fall somewhat short of covering scheduled benefits over the next 75 years. Until recently, President Bush had signaled opposition to any revenue increase to close that shortfall. On February 16, however, President Bush indicated his willingness to consider raising the cap on income subject to the Social Security tax. SSA actuarial estimates show that eliminating the cap would virtually eliminate the projected 75-year funding shortfall.

This shortfall is less severe than is often presented by proponents of Social Security privatization. SSA's projections show that a 1.9 percentage-point increase in the existing payroll tax dedicated to Social Security would close the projected funding gap over a 75-year period. Using slightly less pessimistic economic assumptions about the next 75 years, the Congressional Budget Office (CBO) has estimated the gap could be closed over the next 75 years with just a 1.0 percentage-point increase.

Currently, all earnings up to $90,000 are taxed at 12.4% to fund Social Security. Each dollar earned over and above this cap is completely exempt from Social Security taxes.

This cap affects benefits as well: calculation of Social Security benefits are based on a formula that does not take earnings over the cap into account. Since higher income during one's working life translates into higher Social Security benefits, removing the cap on the benefit side would increase Social Security payments to high-wage earners.

The figure below shows the current actuarial shortfall faced by Social Security under both the SSA and CBO estimates, and the effects of removing the earnings cap on taxes and benefits, based on a 2005 memo by the Office of the Actuary for the SSA. Removing the earnings cap on taxes and benefits improves the 75-year actuarial balance by 1.7% of payroll, thereby eliminating 90% of the funding deficit forecast by the SSA. Removing the cap would completely eliminate the deficit forecast by the CBO with its more plausible economic assumptions.

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This week's Snapshot was written by EPI economist L. Josh Bivens.

Check out the archive for past Economic Snapshots.