What Impact Would Eliminating the Payroll Cap Have on Social Security?

Social Security card and money
Creative Commons photo courtesy flickr user 401(K) 2012.

Monday’s post featuring Boston University economist Larry Kotlikoff and his “34 Social Security Secrets” is attracting viewers like a new Lady Gaga video — at least by Making Sen$e standards. Tens of thousands of you have flocked here in the past 24 hours and you’re spending many minutes on what is, Larry forgive me, a moderately wonky stretch of prose.

Considering that Larry has himself been refining his “secrets” list for about a month now, and working on the issue for many years, there are bound to be questions. As a close FOM$*, he’s willing to answer them. So please pose yours in the comments box below.

Paul Solman frequently answers questions from the NewsHour audience on business and economic news here on his Making Sen$e page. Here is Tuesday’s query:

Name: Judith

Question: How much revenue would come into the Social Security Trust Fund each year and how far out would Social Security solvency be extended if the payroll cap were to be eliminated?

Paul Solman: I’ve just gone back to a story we did on this very subject back in 2005 with Columbia finance professor Stephen Zeldes, “Raising Tax Cap Explored as Way to Close Social Security Gap,” and here’s what I reported at the time:

“Removing the cap entirely, thereby imposing a flat tax of 12.4 percent on all earnings — essentially a $100 billion a year tax increase on the wealthy — would more than completely close the funding gap.”

More recently (Septempter 2010), here’s what Janemarie Mulvey wrote in a report for the Congressional Research Service:

“If all earnings were subject to the payroll tax, but the base was retained for benefit calculations, the Social Security Trust Funds would remain solvent for the next 75 years.”

For those readers who don’t fully grasp the question, or my answer, here’s Ms. Mulvey’s statement of the problem, upon which I can’t much improve:

Social Security taxes are levied on covered earnings up to a maximum level set each year. In 2010, this maximum — or what is referred to as the taxable earnings base — is $106,800. [For 2012, the cap will be $110,100.] The taxable earnings base serves as both a cap on contributions and a cap on benefits. As a contribution base, it establishes the maximum amount of each worker’s earnings that is subject to the payroll tax. As a benefit base, it establishes the maximum amount of earnings used to calculate benefits.

Since 1982, the Social Security taxable earnings base has risen at the same rate as average wages in the economy. However, because of increasing earnings inequality, the percentage of covered earnings that are taxable has decreased from 90% in 1982 to 85% in 2005. The percentage of covered earnings that is taxable is projected to decline to about 83% for 2014 and later. Because the cap was indexed to the average growth in wages, the share of the population below the cap has remained relatively stable at roughly 94%.

*- Friend of Making Sen$e

This entry is cross-posted on the Rundown– NewsHour’s blog of news and insight.