Friday, February 25, 2005

Social Security Reform - Tax Base Issues

As the debate on social security reform begins to unfold, the topic of raising taxes may well be on the table. Everyone knows that a tax is the product of a rate times a base, and in the case of Social Security taxes, that base is earned income (e.g., wages). This base has been growing throughout the history of the Social Security program, and it currently stands at $90,000 for 2005. Thus, amounts above $90,000 are exempt from Social Security taxes (aggregating 12.4 percent, half of which is nominally imposed on employers).

Critics point out that this limit makes the tax regressive, which is true once we compare earners above the maximum rate. The person earning $900,000 pays a smaller fraction of his/her income than the person earning $90,000 or less. However, those earning $90,000 or less are taxed proportionally – if we focus solely on this particular tax. Of course, when you consider federal income taxes, the proportionality goes out the window. Those taxes are progressive, and steeply so.

Given that the benefit structures funded by Social Security include upper limits (i.e., the $900,000 annual earner gets the same benefit as the $90,000 annual earner), it makes sense in this case to limit the tax base. Regressive taxes are not, per se, bad. In this case Social Security functions as a form of forced saving – albeit one that is funded by future payors rather than an accumulation of one’s own contributions. It is a well-known fact that the Social Security benefit structure involves a form of wealth redistribution along economic, as well as temporal, categories by replacing more income for low-earners than high-earners. If further redistribution is desired, it makes no sense to me to accomplish this on the backs of higher wage earners only, while making those with investment income exempt from this burden.

For more on this topic, see our forthcoming newsletter.

Edward A. Morse
Professor of Law
Creighton University School of Law

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