The Social Security Regressivity Ruse

President Biden’s budget proposal included a plethora of “tax the rich” changes with the latest in a long series of misleading and dishonest claims it would make them pay more of their “fair share.” In addition, it also contained a similarly justified and targeted plan to delay the bankruptcy of the Medicare program.

However, despite Biden’s assertion that he would also protect Social Security benefit promises, despite trillions of dollars in unfunded liabilities, his budget proposal essentially ignores the program. But that means it ignores still more burdens that will have to be imposed (no doubt to make sure the rich pay their fair share as well, revealing that that share is always “more”) on top of those already being promised.

But we can anticipate what sort of plan will be coming. On the eve of Biden’s budget rollout, I received an email blast from the left-leaning Center for Economic Policy and Research (CEPR) including their sales pitch about how we should “save” Social Security under the headline, “The Social Security Tax Cap Means Millionaires Don’t Pay Their Fair Share.”

Consider its first paragraph:

“Americans pay into Social Security only on the first $160,200 of their income. ‘If you make over that cap, like 6% of the population does, you could be paying 1% of your income or even less than that,’ Sarah Rawlins tells CBS News. Meanwhile, a worker earning less than that will pay an effective tax rate that is six times higher than the millionaire’s tax burden. Congress can scrap the cap and make everyone pay the same tax rate, significantly closing the projected shortfall.”

The CEPR opening, and especially its headline, makes clear it echoes the same core rationale as Biden’s proposal. Unfortunately, the twin assertions that the rich don’t pay their fair share of taxes in general or of Social Security taxes rest on massive misrepresentation.

As to the first claim, Chris Edwards has pointed out that the Congressional Budget Office, Tax Policy Center and Joint Committee on Taxation have each compared the total tax rates between typical earners and top earners.

They each found that top earners pay more than double the total tax rates than more typical earners (CBO: 26.6% vs. 12.3%; TPC: 25.0% vs. 12.3%; JCT: 30.3% vs. 12.2%). If we only considered income taxes there is an even greater differential (CBO: 3.3% vs. 24.4%; TPC: 3.5% vs. 24.0%; JCT: 5.0% vs. 29.5%), with “the rich” paying over five times the rate of average workers.

In other words, any serious comparison between overall “fair share” evidence and “fair share” rhetoric dramatically defeats the central premise that supposedly justifies taxing the rich more, beyond just stealing more for others at their expense.

As a result, the left needs to find a different example that appears to be unfairly easy on the rich. And that is where the support for raising the Social Security tax cap arises, because the structure of Social Security lends itself to misleading comparisons of burdens, which can be used to claim it is highly regressive, justifying taxing the rich more.

Of course, there are serious but almost never mentioned problems with such tax rate comparisons. One important omission is that a great deal of income for lower-earning households consists of government transfers, and they have increased dramatically in recent years.

The Employment Policy Institute has found that more than 40% of incomes in the lowest quintile come from government transfers, versus 1% for the top 1% of incomes. But those transfers are neither counted in official measures of income nor subject to Social Security taxes.

In other words, those with lower incomes pay a substantially lower Social Security tax rate on their actual incomes than the statutory rate. Adjusting for differences in such excluded income actually makes Social Security taxes progressive as a proportion of income for most earners.

Even if we ignore that problem, and only look at “earned” incomes, the implications of CEPR and other proponents’ statements that Social Security taxes are highly regressive in general are false. Taxes are actually proportional to earned income up to the tax cap. So, for the 94% of Americans who fall under the current $160,200 cap, taxes rise at the same rate as earnings.

Beyond the cap, earnings are not subject to the tax. So for those earners, their average Social Security tax rates fall with further income. Only for that relatively small number can one claim that despite paying more in total Social Security taxes (that is, the statutory maximum) than those with lower earnings, they pay a smaller percentage of their total earnings.

The fact that high income earners do not pay more in taxes beyond the tax cap is why “raise the earnings cap” promoters focus on very high income earners. Substantial earnings beyond the tax cap makes high income people’s average Social Security tax rate look very low, providing ammunition for making them pay more arguments (such as in a 2015 Washington Post article that said “the more money you make, the less your effective Social Security tax rate is, making this tax about as regressive as they come”).

However, if anyone has a claim to be unfairly treated by the system, it is high income earners.

That is because Social Security is a retirement program, making it inappropriate to only look at the taxes paid to determine its progressivity or regressivity. One must incorporate the taxes paid and the retirement benefits received. And on that basis, Social Security has long been progressive, not regressive, as the “fair share” crowd claims.

To illustrate, the Social Security Administration calculated that for workers at full retirement age this year would have the following replacement rates on their indexed average taxable earnings: 75.3% for someone with “very low” earnings; 54.8% for someone with “low” earnings; 40.7% for someone with “medium” earnings; 33.6% for someone with “high” earnings; and 26.7% for someone with “maximum” taxable earnings.

Higher income earners receive a far smaller return on their contributions than average earners, and less than half that of lower earners. Those sharply different replacement rates reflect Social Security’s benefit formula, which is heavily tilted in favor of lower income earners. Lower income individuals get positive net benefits over their lifetimes, but the opposite is true of high earners (and the numbers are far worse for two-earner couples, since both must pay Social Security taxes without proportionate increases in benefits). Taxation of 85% of Social Security benefits for higher income retirees now increases the difference.

Social Security does not benefit high earners at the expense of lower earners. When combined with the benefits financed by the payroll taxes, which is appropriate for a retirement system, Social Security already redistributes income from higher earners to lower earners.

Presenting only Social Security taxes, but not the benefits they finance, and misrepresenting the effects on higher income people, shows how much those who want to raise the payroll cap are willing to use cynical, intentional misrepresentations of regressivity to give them more of other people’s money. But it does not justify hiking the tax cap. 

Gary M. Galles is a professor of economics at Pepperdine University.