Economic Snapshot | Retirement

Top earners get Social Security windfall, others get the bill

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Snapshot for March 9, 2005

Top earners get Social Security windfall, others get the bill

Under the Federal Insurance Contribution Act (FICA), Social Security taxes are collected on individual earnings up to a maximum earnings level, set for this year at $90,000.  The maximum level increases each year, moving up as average earnings increase.  Since 1983, roughly 6% of earners have made above the maximum taxable earnings; because the earnings of this group grew faster than the average American’s did, however, their share of all earnings grew from 25.5% in 1983 to 29.9% in 2001.  Consequently, the share of earnings above the maximum–the amount earned free of the FICA tax–increased from 10% to more than 15% of all earnings.  That is, the highest earners have gotten substantially better off, and their windfall has all been free of Social Security tax.

Growing inequality in Social Security contributions

The argument goes that, because Social Security benefits are also capped, earnings shouldn’t be taxed beyond the point where benefits stop increasing.  It could also be argued, however, that all other workers are required to pay on 100% of their earnings to receive their benefits, as the approximately 94% of Americans earning below the maximum earnings level have done over the last 22 years.  But the best-off 6% of Americans have been taxed at a much lower effective rate. They paid Social Security taxes on 60% of their earnings in 1983, for example, but on only 50% by 2001.  That means that $305 billion in earnings went untaxed for the Social Security trust fund in 1983. The amount of untaxed earnings had increased to $775 billion by 2001 (in 2004 dollars) which if fully taxed would be a loss of revenue in 2001 of around $96 billion.  Medicare, which is funded similarly, does not have a cap on taxable earnings.

While President Bush has declared the Social Security trust fund to be in crisis, we have perversely lowered the tax burden for the highest-earning 6% of America. Maybe that’s why Americans strongly support taxing earnings above the maximum for Social Security.

This Snapshot was written by EPI senior fellow William E. Spriggs.

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