“We must not allow this type of insurance to become a dole through the mingling of insurance and relief. It is not charity. It must be financed by contributions, not taxes.”
-President Franklin Delano Roosevelt (November 1934)
In late June, Senators Bernie Moreno (R-OH) and Elizabeth Warren (D-MA) proposed the full elimination of the Social Security “tax max.” Ever since Social Security payroll taxes were first implemented in 1937, Congress has placed an upper limit on annual earnings that would be subjected to the new payroll tax. Initially set at $3,000 by the original Social Security Act in 1935, the current maximum taxable earnings is $184,500. This number has moved up quickly over the last 10 years, with the maximum pegged at $118,500 in 2016. These levels are set by a 1972 wage indexing formula that was implemented in 1977, with some adjustments in 1989. Since wages have historically risen faster than prices, assuming currently scheduled benefits will continue to be paid, already low poverty rates for seniors are expected to decline substantially over time.
However, Social Security’s finances are not steady going forward. Partially thanks to Americans having fewer children and living longer, as well as several shortsided decisions by Congress to pay out benefits to groups—like well paid government employees—who never earned them, the Social Security Trust Fund is approaching insolvency. If Congress does nothing, Social Security checks received by millions of American seniors across the country will be reduced by 22% around October 2032. Under this threat, Senators Moreno and Warren proposed a big tax increase to help save the program. However, if this proposal actually became law, it would cause serious damage to the very program it is trying to save.
Since initial discussions on creating the Social Security system were conducted by the Committee on Economic Security (CES) in 1934, the program was deliberately designed to be a social insurance system, not a welfare program. President Franklin Delano Roosevelt, who was the key driver behind the idea and appointed the members of the CES, realized from the beginning that a welfare system financed directly by taxes would perpetually be subject to competition against competing federal programs for funding. This would likely cause instability in program funding, limiting benefits and program participation. He clearly intended that Social Security be built as a mandatory system of individual savings, with some extra support for lower lifetime earners, and not in any way resemble a welfare program that has no connection between payments made and benefits received.
The CES initially designed a system that recommended workers who earned more than three times the average annual wage at the time (around $3,000) be entirely exempt from Social Security taxes as well as be excluded from program benefits. This structure would have almost entirely eliminated any redistribution from high to low wage workers, however, and was not implemented. The final structure for Social Security was a social insurance structure, not a welfare system. FDR repeatedly made this distinction clear, focusing on how Americans should have a sense of entitlement to their earned benefits, as opposed to the more traditional relief programs of given benefits.
A former Executive Director of the CES, Edwin Witte, noted how FDR told him and committee members that Social Security “must be self-supporting, without subsidies from general tax sources.” While the President understood that “assistance from general tax revenues would have to be given to people already old and without means,” he still held the strong view that “the only long-term solution of the problem of old age security lies in a compulsory old age insurance system.”
A few years later, FDR explained his support for a social insurance structure to Luther Gulick, an advisor to the federal government. In response to Gulick’s stated opposition to the regressive nature of the payroll tax to pay for the program, FDR responded:
I guess you’re right on the economics. They are politics all the way through. We put those pay roll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program. Those taxes aren’t a matter of economics, they’re straight politics.
FDR later noted to Gulick how the psychological effect of contributions would help “destroy” what he called the “relief attitude.”
In the years since, FDR seemed quite prescient in his vision for Social Security. While welfare programs have expanded or contracted based on economic conditions and political support, Social Security has been remarkably stable over the years, with almost no changes to the benefit formula in decades. Since Social Security is seen by Americans as a program of earned benefits based on savings, and not on welfare, it has been one of the most stable and politically popular programs in the entire federal government.
This is why the Moreno/Warren massive tax increase proposal is so dangerous to the program. Yes, the revenue would partially—but only partially—cover the Trust Fund shortfall, but it would come at the cost of lower support by Americans for Social Security. Program stability would likely be eroded over time, leading to a program that beneficiaries could no longer trust to be there when they retired. The connection between benefits paid in and paid out would be severed, permanently changing the program’s structure. It would be viewed going forward as welfare, not as an earned benefit.
Supporters of tax max elimination would likely chafe at this position, noting how benefits would still be provided to higher income workers. However, with a full elimination of the taxable maximum, unless benefit levels are capped, the agency would eventually start sending out some very large checks. It is possible that SSA could send, for example, over $170,000 a year in Social Security benefits to someone who earned a million dollars a year in their working years. So a cap on benefits, or the insertion of a “bend point” so draconian that there is effectively a cap on benefits, is quite likely to be included in any measure to “scrap the cap” on taxable earnings.
It is also important to note how detrimental eliminating the tax max would be for the economy. The Tax Foundation has recently pointed out that the Moreno/Warren proposal would yield the largest tax increase in decades, “significantly harming” the economy. The increase itself, 12.4% on all income over the tax max, would account for around 0.83% of GDP. In higher tax cities and states, overall tax burdens could approach or exceed 60% of income for higher earners, which is well above the “revenue-maximizing” rate estimated by government economists. This means that this tax increase itself would cause lower economic output and lower productivity. The Tax Foundation estimates that this proposal would lower long-term GDP by 1.5% and cost over 1.8 million Americans their jobs. The Penn-Wharton Budget Model earlier estimated a higher reduction in GDP if the tax max were to be eliminated, at 1.7%. The economic pain from this proposal would hit everywhere, including in Senator Moreno’s state of Ohio, where a small business owner could face a total marginal tax rate of 56%. This would create a chilling effect on the businesses that create most of the new jobs in this country, lowering economic growth for years to come.
Even with all the economic pain that the Moreno/Warren plan would create, it would still not come close to fixing Social Security. First off, while some estimates show that the proposal could raise $3.2 trillion over the next 10 years, when including negative effects this proposal would wreak on the national economy, the Tax Foundation estimates this number to be actually around $1.5 trillion. And this could even be generous. Higher income individuals would likely adjust by taking in compensation in other forms outside of income, like stocks and other capital goods, or by shifting economic production to lower tax jurisdictions. With this lower revenue estimate, the proposal does not come close to covering the estimated $25 trillion needed to bring Social Security into balance over the next 75 years. Even the more generous models run by SSA estimate that scrapping the tax max would only bring back annual surpluses for around three years, and at best close less than 70% of the long run shortfall.
It’s not likely that clear warnings like this will be enough to encourage Senators Moreno and Warren to change course and withdraw their dangerous tax max elimination proposal. Their argument focuses on how a coal miner should pay the same portion of their pay into Social Security as the corporate lawyer, ignoring the dangers of their plan, which would likely put the entire program at risk going forward. Rather than stabilizing Social Security, their plan would go directly against the wishes of FDR when he created the program over 90 years ago. In his words, Social Security would become more “charity” than “insurance.” And it would not fix the shortfall, to boot.