Time to raise – or scrap – the Social Security payroll tax cap

It’s Tax Day, and a small number of wealthy Americans will have something to celebrate: They’ll be done paying Social Security taxes for the year.

The payroll tax that funds Social Security is levied only on a certain amount of income. This year it’s capped at $117,000. That means most wage earners will pay 6.2 percent of every dime they earn in 2014, but high earners will stop paying after passing the cap. If you’re among the 318,400 workers who will earn $407,000 or more this year, you’re done paying Social Security taxes today, according to the Center for Economic and Policy Research (CEPR), a progressive think tank. On June 15th, 2 million taxpayers will be done, 3.7 million on Sept. 15th.

This means some people face a much higher Social Security tax rate than others. Under the Federal Insurance Contributions Act (FICA), the Social Security tax is applied as a straight percentage of income; it’s levied at a rate of 12.4 percent of income (minus employer-provided healthcare and life insurance), split evenly between employees and employers, up to the cap. If you earn anything up to $117,000 per year, your rate is 6.2 percent of total income; if you earn $250,000, it’s just 2.9 percent.

That’s not how the system was designed. The clear intent of Congress – expressed in 1977 revisions to the Social Security Act of 1935 – is that 90 percent of all payroll covered by the Social Security system should be taxed. Under the law, the cap is adjusted annually to reflect wage inflation, but the flattening of wages for most Americans – and runaway income at the top – means that more income “escapes” the cap.

Currently we’re collecting on just 82 percent of the wage base. Weak wage growth and rising earnings inequality are key culprits, along with the rising value of fringe benefits such as health insurance. They are driving of the projected long-term shortfalls in the combined retirement and disability trust fund, which is expected to be exhausted in 2033 absent any reforms. Social Security would then be able to pay 77 percent of scheduled benefits.

That has put the cap at the center of the debate over Social Security reform. My Reuters column today explains why it’s time to raise – or scrap – the payroll tax cap.