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March 7, 2005
By Rea S. Hederman, Jr. and Tracy Foertsch, Ph.D.
Members of AARP
must be feeling a bit whipsawed by their Washington leaders these
days. On the one hand, AARP leadership says that private accounts
in Social Security, which could be invested in the stock market,
are like gambling. On the other hand, AARP encourages its members
to invest their retirement savings in the stock market.
If that isn't
confusing enough, AARP now proposes a massive tax increase for many
of its own members, on whose behalf it advocates, as part of its
Social Security reform plan. AARP's Social Security plan would:
Security plan would raise taxes for many of its own members,
threaten some of their jobs, and slow the economy on which they all
depend. And after asking all that sacrifice of its members, AARP's
plan would not even fix Social Security.
On February 9th,
AARP CEO Bill Novelli spoke at the National Press Club on Social
Security reform. In that speech, he proposed raising the cap on the
amount of wages subject to the Social Security payroll tax by
$50,000. Novelli said that increasing the wage cap from $90,000 to
$140,000 would reduce the Social Security 75-year shortfall by 43
This assumes, on top of raising the wage cap, higher taxes
elsewhere or more borrowing to repay the bonds in Social Security's
Workers now pay Social Security payroll taxes
on the first $90,000 of their annual income. That "wage cap" is
indexed to the growth of real wages in the economy and increases
every year. For example, the wage cap in 2003 was $87,000, and it
rose to $87,900 in 2004 and $90,000 in 2005. Currently, about 85
percent of wages fall within the wage cap. The AARP plan would
raise this to 90 percent.
Payroll taxes are
evenly split between the employer and the employee. Under the AARP
plan, workers earning under $140,000 would lose 6.2 percent of
their wages and salaries above $90,000 to payroll taxes, and their
employers would pay the same additional sum. This distinction,
however, is artificial. In effect, say most economists, the
employee pays both the employee and the employer share of the
payroll tax in the form of reduced bonuses, wages, and
The last time the
share of taxable wages covered by Social Security reached 90
percent was in 1983, following the enactment of the Greenspan
Commission's recommendations. Between 1983 and 2003, increases in
the number of higher-paid earners gradually reduced the share of
total wages paid into Social Security to 86 percent. If enacted,
AARP's proposed increase in the wage cap would lead to a sharp jump
in the share of wages covered and, as a result, a huge tax increase
on American workers.
Raising the wage
cap has been a very popular way to increase Social Security's tax
revenues, even though it has never succeeded in putting the program
on firm financial footing. When Social Security was created in
1937, the wage cap was $3,000, or about $39,500 in 2004 dollars.
Under the AARP plan, the wage cap would amount to about 3.5 times
the original cap.
million workers exceeded the wage cap in 2003, according to data
from the U.S. Census Bureau's March Current Population Survey.
These workers would face a major increase in taxes under AARP's
proposal. Of those 9.8 million workers, over 3.6 million are over
50, and over 600,000 are 62 years or older. Many workers over 50
are in their peak earning years and are to be hit hard by any
payroll tax increases. Workers over 62 may simply chose to retire
early and avoid altogether the sting of AARP's Social Security
AARP's plan would impact many families' finances. About 7.8 million
workers of the workers who would face higher taxes are married.
And about 3.3 million of those workers
are not the heads of their households; facing much higher marginal
tax rates, many of these workers may choose to exit the workforce
or scale back their employment.
economists used the Global Insight U.S. Macroeconomic Model to
estimate the impact on the economy of raising the wage cap to
The $543 billion increase in payroll taxes between 2006 and 2015
would likely eliminate an average of over 469,000 potential job
opportunities per year. It would also reduce economic output, each
year pushing GDP an average of $38.7 billion (in 2000 dollars)
below the Global Insight model's baseline forecast.
would also be squeezed. Over the ten-year period, disposable income
would decline by an average of some $546 per year for a family of
four over the ten-year period. Personal saving would subsequently
drop below the Global Insight model's forecasted baseline, as would
business investment. In other words, AARP's plan to strengthen
Social Security would actually weaken other retirement saving.
A recent report from the Social Security
Administration (SSA) examined the effects of not just raising the
wage cap, but of eliminating it completely. SSA's actuarial study
showed that eliminating the payroll tax cap entirely would only
delay the start of Social Security's annual deficits by six years,
from 2018 to 2024. Eliminating the wage cap on payroll taxes while
paying benefits on only the first $87,900 of earnings would delay
the start of annual deficits by an additional year, to
If real-life economic changes were considered,
six years would be the maximum amount of time that the deficit
would be delayed. As individuals retire earlier or cut back their
work hours, Social Security's trust fund would reach insolvency
even more quickly.
Raising the wage cap would delay the onset of
massive deficits by only a few years. As Social Security now
stands, annual deficits will first reach $100 billion a year (in
2003 dollars) in 2022, according to the 2003 Social Security
Eliminating the wage cap delays $100 billion deficits until 2029,
or only seven years. Subjecting all earnings to payroll taxes but
only paying benefits on income up to the current wage cap only
delays the start of those $100 billion deficits until
If completely eliminating the wage cap only
delays deficits by six or seven years, raising the cap to $140,000
would not even delay the crisis by that long.
Raising the wage
cap is not the right solution to solve Social Security's looming
financial problems. Even AARP admits that raising the wage cap to
$140,000 would at best erase less than half the projected shortfall
in Social Security. And it would only do so at a high economic
cost, eliminating hundreds of thousands of jobs and slowing overall
economic growth. While always politically popular, raising taxes on
the "rich" is not an effective policy tool.
could better serve their members by examining options for Social
Security reform other than a tax increase on some 3.6 million of
its potential members that, in the end, doesn't even fix Social
Rea S. Hederman,
Jr., is Manager of Operations and a Senior Policy Analyst,
and Tracy Foertsch is a
Senior Policy Analyst, in the Center for Data Analysis at The
 See Stuart M. Butler,
"Schizophrenic Over Social Security," Heritage Foundation
Commentary, February 9, 2005, at http://www.heritage.org/Press/Commentary/ed020905c.cfm.
AARP & Social Security: A Background Briefing," February 9,
 See David C. John,
"Misleading the Public: How the Social Security Trust Fund Really
Works," Heritage Foundation Executive Memorandum No. 940,
September 2, 2004, at http://www.heritage.org/Research/SocialSecurity/em940.cfm.
 Heritage economists
used the most recent Global Insight U.S. Macroeconomic Model to
estimate the impact on the economy of raising the wage cap to cover
90 percent of wages, which would be $140,000 in 2005. The Global
Insight model is a dynamic model frequently used by private-sector
and government economists to estimate how changes in government
spending and tax policy are likely to impact the general
The Global Insight
model contains a number of variables that can be used to simulate
the AARP's proposed policy changes. An increase in the wage cap for
Social Security was introduced into the Global Insight model
assumptions, conclusions, and opinions in this memo are entirely
the work of Heritage analysts. They have not been endorsed by, and
do not necessarily reflect the views of, the owners of the Global
 Chris Chaplain,
Actuary, and Alice H. Wade, Deputy Chief Actuary, Social Security
Administration, "Estimated Long-Range OASDI Financial Effects of
Eliminating the OASDI contribution and Benefit Base." Numbers in
this memo have been converted into 2003 constant dollars by The
Heritage Foundation. See David C. John, "Raising the Wage Cap Does
Not Fix Social Security," Heritage Foundation WebMemo No.
667, February 16, 2005, at http://www.heritage.org/Research/SocialSecurity/wm667.cfm.
Administration, 2003 Annual Report of the Board of Trustees of
the Federal Old-Age and Survivors Insurance and Disability
Insurance Trust Funds (Washington, D.C.: U.S. Government
Printing Office, 2003), at http://www.ssa.gov/OACT/TR/TR03.
AARP's Social Security plan would raise taxes on its members andthreaten their jobs.
Rea S. Hederman, Jr.
Director, Center for Data Analysis and Lazof Family Fellow
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