March 7, 2005 | WebMemo on Social Security
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:
AARP's Social 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 percent. This assumes, on top of raising the wage cap, higher taxes elsewhere or more borrowing to repay the bonds in Social Security's Trust Fund.
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 benefits.
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.
Approximately 9.8 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 plan.
In addition, 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.
Heritage economists used the Global Insight U.S. Macroeconomic Model to estimate the impact on the economy of raising the wage cap to $140,000. 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.
Family budgets 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 2025.
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 trustees report. 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 2031.
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.
AARP's leaders 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 Security.
 See Stuart M. Butler, "Schizophrenic Over Social Security," Heritage Foundation Commentary, February 9, 2005, at http://www.heritage.org/Press/Commentary/ed020905c.cfm.
 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 economy.
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 by:
The methodologies, 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 Insight model.
 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.