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retirement.12

the 2004 Nobel Prize in economics, has com-

pared high-tax societies in Europe with the

For all these working men and women, rais-

United States and found that workers respond

ing the cap would immediately increase their

to the incentives supplied by marginal tax

marginal tax rate--the amount of taxes paid on

rates. The higher marginal tax rates in Europe

each additional dollar of income earned--by

clearly discourage labor. In fact, Europeans

roughly 10 percentage points (less than the full

work a full 50 percent less than Americans.

12.4 percent because the employer's half is tax-

That is a change from the early 1970s, when

deductible). Most of the affected workers are

individual Europeans worked nearly 50 per-

already paying federal income taxes at the top

cent harder than Americans.16

rate of 35 percent. Moreover, as Cato senior fel-

low Alan Reynolds has pointed out, the effec-

Raising the tax cap is also likely to reduce

tive marginal tax rate for those workers is actu-

national savings, since the upper-income

ally 2 to 3 percentage points higher than the 35

households that would be subject to the

percent rate, because itemized deductions

increased taxes are also those that do much

begin to be phased out if income tops $142,700

of the nation's saving. More than 84 percent

and personal exemptions are phased out above

of those in the top 10 percent of incomes

$214,050. Therefore these workers are already

report saving during the previous year,

paying marginal tax rates in the range of 42 per-

whereas fewer than a third of those in the

lowest 10 percent do.17

cent. And that doesn't count state income taxes,

which can add approximately 5 percentage

The Heritage Foundation estimates that

points to marginal tax rates. Throw in the 2.9

removing the cap would reduce the rate of

percent Medicare tax, which is not capped, and

U.S. economic growth by 2­3 percent. Over

upper-income workers are already facing mar-

the next 10 years, it would cost the U.S. econ-

ginal tax rates of over 45 percent. That is, near-

omy nearly $136 billion in lost growth. In

ly half of every additional dollar earned is taken

addition, roughly 1.1 million jobs would be

in taxes.13

lost over the next 10 years.18

Adding 10 more percentage points by elimi-

Yet, in exchange for this massive tax increase

nating the cap on Social Security taxes would

and its attendant costs, Social Security would

increase this to 55 percent. That would give the

gain very little.

United States one of the highest marginal tax

rates in the world, exceeding even such notori-

The Effect on Solvency

ously high-tax countries as Germany (47 per-

cent), and roughly equal to that of Sweden (56

percent).14

A worker earning

Advocates of removing the cap often

make grand claims about its impact on

Small businesses would be particularly

$100,000 per year

Social Security solvency. For example, the

hard hit. In fact, about one-third of the work-

would directly or

Economic Policy Institute suggests that elim-

ers affected by raising the cap would be small

ination of the cap would reduce Social

business owners. Gene Steuerle of the Urban

indirectly pay

Security's 75-year funding shortfall by as

Institute believes that an increase in the pay-

$1,240 more in

much as 90 percent.19 However, those claims

roll tax cap would have a disproportionate

taxes each year.

impact on small businesses, because of the

are based on a fundamental fallacy: the

difficulty in differentiating between earnings

assumption that Social Security surpluses

from work and earnings from investment in

accumulated today can be saved through the

their businesses.15

Social Security Trust Fund.

Social Security payroll taxes are currently

Although there has been relatively little

bringing in more revenue than the program

analysis of the economic consequences of rais-

pays out in benefits, a surplus that is project-

ing or eliminating the payroll tax cap, it seems

ed to continue until approximately 2017.

fair to assume that they would be consider-

Thereafter, the situation will reverse, with

able. For example, Edward Prescott, winner of

5