Breaking Social Security's Glass Ceiling

"Like Topsy," one critic of Social Security financing has written, "the payroll tax just grows while no one is looking." Actually, there are some people looking, and they are reasonably satisfied with what they see in the present structure of the FICA funding system.

Organized business likes what it sees, because the employer half of the 15.3 percent payroll levy (as numerous economists, including conservative Nobel laureate Milton Friedman, have admitted) is really paid indirectly by the employees themselves. Studies of various industries done at the Brookings Institution during the 1970s concluded that the higher the employer's raw tax (a figure equal to the money withheld from workers' wages), the lower the after-tax wages of the employer's workforce by roughly the same amount. The employer half of the FICA tax, in other words, is made up of lost employee wages.

Employers also benefit from being able to avoid full taxation of their payrolls. President Jimmy Carter, not usually considered an economic liberal, tried in vain to modify the pro-employer bias in the law during his term in the White House. Although acquiescing in the regressive flat-rate structure preserved in the 1977 FICA rate increases, he attempted to shift some of the immediate financial burden away from workers by removing the employer "cap" and taxing business payrolls in their entirety, not just that portion matching employee withholdings; Congress, subjected to heavy corporate lobbying, refused to go along. Had it done so, the United States would have joined such enlightened countries as France, Belgium, Great Britain, Sweden, Denmark, Norway, Italy, Spain, and Portugal in taxing employers more than employees for social insurance purposes.

American business interests are not alone in favoring the status quo for funding Social Security. High-end earners also like what they see in the current system. The existing tax structure imposes an employee cap or ceiling on the amount of annual salary income subjected to the designated Social Security portion (6.2 percent) of the 7.65 percent individual FICA tax. (The Medicare tax cap was removed in 1993 with no fanfare and no apparent ill effects.) At present, the cap, which is adjusted periodically as average earnings rise, is set at $76,200; no salary or wage income above that level is taxed. This is an obvious financial gift to those at the top, the estimated 6 percent of employed earners -- roughly 10 million in all -- whose annual incomes exceed the established ceiling.

Here's how some selected taxpayers are impacted under the capped system: A wage earner making $35,000 a year has 100 percent of his pay taxed, contributes $2,170 under the Social Security portion of FICA, and has a real tax rate of 6.2 percent. A salaried employee making $200,000 a year has 36.3 percent of his pay taxed, contributes $4,501 to the government, and has a real tax rate of 2.25 percent. A corporate executive taking home $1 million a year in salary has 7.26 percent of his earnings taxed, also pays $4,501 to Social Security, and has a real tax rate of 0.45 percent. Of course, the millionaire actually does even better, since according to economic statistician Andrew Hacker of Queen's College, American millionaires typically derive only one-third of their incomes from employment; the remainder comes from unearned sources (dividends, interest, royalties, capital gains) that aren't taxed at all under FICA.

Given that all three of these individuals collect Social Security benefits, you might reasonably ask why they are taxed unequally and why their contribution rates go down as their earnings go up. Answers are surprisingly hard to find. The excuse offered in the 1930s, when the program was first established, was that taxing the wealthy more heavily would prevent the accumulation of capital and curtail needed industrial expansion. While plausible in the midst of the Great Depression, that argument waxes thin in today's heady era of economic expansion.

In more recent times, the issue of fairness has ironically been raised by some apologists for the cap. Low tax rates at the top, it is said, merely offset comparatively higher benefits at the bottom. Under Social Security's "weighted benefit" formula, which results in retirement payments being a somewhat higher percentage of low average lifetime earnings than of high average lifetime earnings, it is true that richer beneficiaries are disadvantaged in the abstract. However, eliminating the discriminatory cap on taxable income could be easily done in conjunction with a slight sweetening of the benefit pot for those unfortunates suffering from high incomes, if only for psychological reasons.

It has also been argued that removing the cap would generate too much opposition in Congress from members influenced by their more affluent constituents. With Republicans in control of both houses of the legislative branch, reform would certainly be more difficult than in 1993, when a Democratic Congress ended the Medicare cap. Nevertheless, the GOP won't be exclusively in charge forever, perhaps not even beyond next November. And an aroused public, cognizant of how FICA really operates, could make all the difference, regardless of party majorities. Difficulty, in any case, is no excuse not to pursue needed change.

A real tax reform, one that would impact middle- and lower-income Americans, is long overdue, and it lies in revamping FICA, not in tinkering with the income tax as our major-party presidential candidates propose. Senator Ted Kennedy, the old liberal lion, has shown the way. His 1997 proposal to scrap the cap would have permitted a 1 percent reduction in the individual Social Security tax, while maintaining existing revenues by adding new, wealthy taxpayers to the rolls. The result: an annual tax cut of about $300 for average Americans in the $35,000 income category. A more recent variation by The Nation magazine's William Greider (a 2 percent cut in the employee half of FICA alone, also financed by removal of the cap) would give $700 a year back to that same worker.

Rich Americans would pay substantially more under either scenario -- perhaps $50,000 a year more on average for those with annual earnings above $1 million -- but to be perfectly blunt about it, so what? Those who took more than their share of the economic benefits during the last two decades of income-tax giveaways and earnings gaps should be willing to redress the balance by anteing up in the new millennium. Some version of the Kennedy/Greider approach, a revenue-neutral plan based on financing low-end tax cuts with enhanced contributions from formerly exempt taxpayers at the top, is genuine tax reform that would contrast sharply with the pabulum being served up by candidates Bush and Gore. We might even consider going one better by applying the FICA tax to investment and other non-salary income, and by making it more progressive through incorporation of the graduated-rate principle. Now that would be a real populist tax reform.

Wayne O'Leary is a writer in Orono, Maine.

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