It was former President Bill Clinton who several years ago set out the limited options for Social Security reform: cut benefits, invest privately, or raise taxes. During last Wednesday night's Democratic candidate debate, his wife refused to put any of those options on the table. But the other Democratic contenders weren't as hesitant: Five candidates, including John Edwards and Barack Obama, supported lifting the cap on payroll taxes to finance the system.
Currently, only the first $97,500 of annual income is subject to the payroll tax. Edwards in particular was adamant about taxing earners who make over $200,000 a year. But while soaking the rich may be a politically popular approach, the reality is that this enormous tax hike would seriously damage the U.S. economy while doing very little to save Social Security.
Eliminating the cap on payroll taxes would be, by far, the biggest tax hike in U.S. history: more than $1.3 trillion in new taxes over the first 10 years alone. As bad as that would be in the aggregate, it would be even worse for individual workers. A worker earning $103,000 per year would pay $1,240 more in taxes each year.
And raising the tax cap would not just impact the super rich, as is often argued, but would fall most heavily on the upper middle class. Census data indicates that some 9.2 million Americans would see their taxes increased. Roughly three quarters are managers or other professionals such as doctors, lawyers, and engineers. 16 percent work in sales or office occupations, while the remainder includes teachers, nurses, truck drivers, farmers, and police officers. Small businesses would be particularly hammered: about one-third of the workers affected by raising the cap would be small business owners.
Eliminating the cap would saddle the United States with the highest marginal tax rate in the world, higher even than countries like Sweden. Studies suggest that it would cost the United States as much as $136 billion in lost economic growth over the next 10 years, and as many as 1.1 million lost jobs.
In exchange for this economic catastrophe, we would gain surprisingly little in terms of Social Security's finances. Even the most drastic, and politically unlikely proposal — completely eliminating the cap without allowing any additional credit toward benefits — would result in only eight additional years of cash-flow solvency. Rather than beginning to run a deficit in 2017, Social Security would continue to run a surplus until 2025. That's very little gain for so much pain.
Nor would eliminating the cap address Social Security's other problems. It would not enable workers to decide how their money is invested. It would not allow low- and middle-income workers to accumulate a nest egg of real, inheritable wealth. It would not improve Social Security's rate of return for younger workers.
On the other hand, proposals for personal accounts would give workers ownership and control over their retirement funds. Combined with measures to restrain benefit growth, these proposals could do far more for Social Security's solvency than busting the cap.
This is a debate we should have. Do Americans want a massive tax hike in exchange for propping up the current Social Security system for a few more years? Or do they want fundamental reforms that give them more ownership and control of their money?