Monday, April 29, 2019

Our Truly Regressive Tax: Social Security

Our Truly Regressive Tax: Social Security
A reader asked me a good question last week, after reading my jumbled rant on systemic problems, and the individual tactics that aren't going to solve them. What, short of running for public office, can we citizens do to encourage systemic solutions?

I have to admit that stumped me a bit. Thinking about changes to the system is nice. Actually coming up with plans to do so is harder.

Executing them? Who even knows how to do that?

So let's give that a try today. Let's talk about the system we use to fund most Americans' retirement: Social Security, one of the few truly regressive taxes out there.

Social Security currently taxes employees 6.2% on all wages up to $132,900. It also taxes employers the same amount on each dollar earned. But then, each dollar earned above $132,900 is taxed at the oh-so choice rate of....0%.

So the tax system has two tiers, and they're backwards: the more you make, the lower your effective tax rate. This results in a Social Security tax system that looks like this:

Our Truly Regressive Tax: Social Security

The working poor, middle class earners, and people earning $132k annually all pay the same flat rate of 6.2%. But then after that point, the more you earn, the lower percent of your wages go to Social Security taxes.

It doesn't seem fair that someone earning minimum wage would pay a higher percent of their income into the system than someone earning a million dollars.

Luckily, the Democrats have a proposal coming through the House that is sure to address this nonsense. It's called the Social Security 2100 Act and I'm sure it'll fix everything. Systemic solution nirvana, here we come.

So, flipping through the high level details it, um...
  • Leaves Social Security Taxes at 6.2% for everyone earning up to $132,900
  • Starts applying that same 6.2% on income over $400,000
  • But then creates a doughnut hole where all income between $132,900 and $400,000 is still taxed at 0%
  • Over the next 24 years, payroll taxes would increase from 12.4% (split evenly between employees and employers) to 14.8%, on income up to $132,900 and above $400,000
  • Over time, the $132,900 income cap would increase, shrinking the doughnut hole and eventually eliminating it altogether, effectively creating a truly flat tax at 7.4% for the employee.
Yikes. I thought we were the party that knew how to reform tax law.

Here's what the Social Security 2100 Act would do to effective tax rates in its first year. (Rates would very slightly increase every year after that, until flattening at 7.4%.)

Our Truly Regressive Tax: Social Security

While it's nice to see that income above $400,000 would start to be taxed above, you know, 0%, the doughnut hole keeps the effective tax rates of high earners much lower than the rates that everyone earning less than $132,900 is paying. Even someone earning a million dollars pays a lower percent of his income into Social Security than a minimum wage worker.

Look, I'm sympathetic to the parts of the bill which increase the minimum benefit to the poorest retirees. It's a worthy goal. And I love the idea of making systemic changes to Social Security to ensure it's properly funded going forward.

But I can't for the life of me understand why this was thought to be the best approach to fixing the system. In what world should the worker earning $400,000 (not as a family, mind you: an individual worker) pay the lowest Social Security tax rate of anyone in America?

Even the Republican wet dream of a truly flat tax would be a better approach. What if they just taxed all earned income at 6.2% right out of the gate, instead of messing with a doughnut hole?

Our Truly Regressive Tax: Social Security

This would at least be far more fair than either the current regressive system or the strange, doughnut-hole-to-flat-tax incrementalism the Social Security 2100 plan proposes.

Still, I think we can come up with a better solution. Why not implement a progressive tax system, and stop taking 6.2% from the working poor altogether, while still providing them the same level of benefits in retirement? 

And to those wondering where the money would come from if we stopped taking $1,240 in taxes a year from someone making $20,000 (a sum that means little to the federal government but means a ton to someone trying to live on the minimum wage), why not try to make up the delta by going after people who are making serious money?

And if we're going to put a cap on the system for the wealthy, why not cap benefits at the level of someone earning $132,900 but continue to tax the income above that level?

Here's a half baked plan that copies from our progressive income tax system.

Which would create effective tax rates that look like this:

Our Truly Regressive Tax: Social Security

People much smarter than me would need to, you know, run numbers to see if sufficient funds would be collected to properly fund Social Security. 

But the solution to a two-tiered regressive tax, like we have with Social Security, isn't a doughnut hole that still rewards everyone earning in the six figures. It's not a flat tax. With Democrats in control of a house of Congress I think they should have the guts to push for a truly progressive tax system.

If Democrats are going to have an income band where people pay a zero percent tax rate, it shouldn't be on the income between $133,000 and $400,000: the income band where people pay zero percent should be down where people are making close to zero dollars. 

Maybe I'm naive and greedy, and am asking too much of the Democratic party. But is it too much to ask to create a system where the working poor pay a lower rate than the guy earning a million a year?

As always, thanks for reading.

Side note: If you'd like to nudge your representative to come up with a bolder, more progressive policy solution to shore up Social Security, you can find his or her contact information here

*Photo is from the Fabricator of Useless Articles, which is coincidentally also what my mom calls me when telling her friends her son is a blogger, at Flickr Creative Commons.


  1. The FICA taxes have always baffled me, and this new system sounds only marginally better. I mean, at least the truly high earners get taxed, but I'd think there are a lot more people making $132k to $399,999 than there are at $400,000+. So we're losing out on a lot of potential revenue.

    That said, even with a House that's Democratically controlled I'm doubtful that Democrats can push the bill through the Senate. So it's probably all moot anyway. In case you can't tell, today's a pessimistic day.

    1. Yes, that doughnut hole does mean we're missing out on a LOT of revenue, Abby.

      And if I can add to your pessimism with some cynicism, this doughnut hole with the 0% tax rate just happens to coincide with the salaries of Congresspeople. It's quite a coincidence.

      I agree that the Senate isn't likely to take up the 2100 plan, flawed as it is.

      That's kind of why I wish they'd have the guts to propose a truly bold, and much more fair, proposal. If it's not going to get past the GOP Senate, why not push for a bigger idea that actually creates some semblance of a fair solution?

  2. I have not been keeping up with the logic behind this system as closely as I should. Thank you for putting this post together with the facts and stats included.

    This point really struck me:

    "It doesn't seem fair that someone earning minimum wage would pay a higher percent of their income into the system than someone earning a million dollars."

    I didn't even know this was the case! I will have to fully integrate this information before I can even express any more of an opinion.

    What I just described about myself is part of the problem. Issues like these are so complex for busy people keeping track of a million things. People have to do real research, let the information and the implications sink in, and THEN form an opinion instead of relying on sound bites from news stations.

    1. I appreciate that approach you're taking, Savvy History. And thanks for stopping by!

      I, too often, will jump to conclusions without taking in all the facts. I certainly don't know if the progressive tiers I proposed are anywhere near the right solution, either.

      But I do think a regressive system of taxing is far inferior, and far less fair, than a progressive tax system. Of that I feel sure.

  3. I certainly don't think the current system is done well, and I don't have the best solutions in my back pocket, but I will give the overall Social Security system credit for being much more progressive overall than what the taxation rate indicates. On the back end the benefits are highly progressive. When calculating benefits the first $926 of AIME (average indexed monthly earnings over 35 years) is given a benefit of 90%, then income between $926 and $5,583 is given a 32% benefit and income over $5,583 is given a 15% benefit.

    1. Hi there, John.

      I agree that the benefits structure is quite progressive: low earners who are below the first bend point see the best ROI on their contributions, high earners who get past the second bend point see the worst ROI.


      Taxes have to be paid now with some pretty significant impacts on low workers. Benefits aren't seen for many years later: many workers will die before they see all the expected benefits. And, due to the underfunding of Social Security, many of those benefits will have to be reduced.

      So that's why I focused on the tax side of the equation for now, which is regressive and, at best, seems just out of step with the progressive nature of the benefits.

  4. I think it is important, when having these conversations to a) understand legislative history and b) understand political realities. Now I'm no expert, but I've done a tiny bit of research because I've always been curious about the SSN cap (currently at ~$132K) and have recently been curious about the proposed donut hole proposal. Working backwards:

    1) I agree that on the surface the donut hole doesn't make a lot of sense. However, if you think about it politically it makes a ton of sense. Simply put, it is implementing new SS taxes at the high end, and then allowing the ever growing cap to eventually close the hole. That is 1000x more politically savvy than just blasting everyone over $132K with new taxes. They would "save" social security but they would get absolutely crushed in the very next election because there are a LOT of people who vote and get vocal that make over $132K. In my mind, this is no different than what Trump and McConnell just pulled. They put in a huge PERMANENT corporate tax cut, and a TEMPORARY personal tax cut that expires in 2025, well after they are out of office. Net net, with a bit of slight of hand, they change things and aren't around to hear the complaints when the real pain comes.

    2) So why is there a SS cap in the first place? It's a little vague but it seems FDR's original proposal exempted high earners from the program altogether (both the tax AS WELL as from receiving any benefits). As it worked its way through Congress, the exemption was dropped in favor of the cap. Again, I'm not sure the program would have passed AT ALL without compromises at the time. I'll leave that to the Congressional historians.

    1. Tin!

      Mrs. Done by Forty and I discussed the political viability of the Democratic proposal and we agreed that this was likely why the 2100 Act was set up the way it was. It's a politically viable approach.

      However, I'm not particularly optimistic it will go anywhere in the Senate. I think that if that's the case, they're far better off putting forth their truest & best solution for Social Security (which similarly will not pass the Senate) so voters at least can see there is one party trying to fix the sad fact that the lowest paid workers pay the highest effective tax rate.

      Maybe I'm just being idealistic (or naive) though.

      I will do some digging on the history of the cap. Maybe a future post is in order!

  5. As an Aussie, it’s fascinating to see you look at taxation somewhere else.

    I know in Australia we have a “tax free threshold” where you’re not taxed. And then each tranche is taxed an increasing rate. It works, I think, and inherently covers social security (we just have one lump of payroll taxes, unlike the US which has state and federal I understand).

    The hole annoys the heck out of me. But also; our system has personalised payments for retirement (called superannuation) which is 9.5% of your salary. This is different to payroll taxation and social security though... so I’m starting to get confused! Anyhow, thank you to alerting me to the proposed change and the hole.

    1. Hi Sarah! Sorry for the late reply.

      I love the idea of wrapping all this into income taxes (because we already have a very nicely progressive tax system there). That would be a very neat solution to try to copy from in the US.

      Agree that the hole is dumb and annoying. I am particularly annoyed because my Democratic party came up with this plan, and I think it's pretty seriously underwhelming and creates a system only marginally better than current state.

  6. Ugh! I'm disappointed. The donut hole seems ridiculous. I'd just change the $132,000 cap to $400,000. Then maybe drop the rate for $400,000 and above. Change the benefit curve for those people who paid a lot into it. They should get something back.
    Thanks for the post.

    1. Hi Joe! I like the idea of raising the cap to $400k. But, rather than it going to a lower rate for higher earners above that amount, I clearly would prefer a higher rate.

      I hear what you're saying about people who paid a lot into Social Security not getting a lot out of it after the 2nd bend point. But I guess I just have very little sympathy for those earning above $400k not getting a good ROI on SSI. If there are extra benefits to be passed out, I want them going to people on the other end of the income spectrum.

      But different stroke for different folks.

  7. I feel a LOT smarter having read this one. Great write up, DBF! I tend to agree that a progressive tax makes good sense here. But since SS is supposed to come back to the earner later in life, it probably isn't the biggest flaw in our system. (course that logic really does assume you get later what you put in today.)

    1. Good point about the catch with contributions going back to retirees later.

      I think of Social Security much more like a pension style safety net system rather than a true retirement system. As such, the main goal is to make sure that it's properly funded. That's where my post is trying to take this: top earners shouldn't be paying the lowest rates into a system that is underfunded, IMO. Fix that, and you fix the funding problem of Social Security. (But yeah, plenty of ways to skin the cat. I'll settle for a true flat tax.)

  8. I'd prefer to look at severely limiting benefits for high earners (eliminating them for earners over $1m/year) and limiting spousal benefits for high earners as solutions rather than tinkering with the rate. I'd like the program to go back to being a safety net for the poor rather than a retirement savings plan for everyone. I'd change the taxation of benefits and apply it to state/local workers. There are many options that can work together that might not have as much political pushback and even if some of them made it through the process, we'd be making progress. I like to use the various tabs/options on this tool to see how small changes make a difference.

    1. Thanks for sharing that tool. Will check it out!

      I am open to addressing the benefits side of the equation (I'm in favor of capping benefits at the levels for earners at $132k, for example). But I'm obviously not in favor of keeping the current regressive tax system. It really makes no sense for the highest earners to pay a lower percent than the working poor.

      I've yet to hear a convincing argument for keeping that system as is.

  9. I believe I was one of the readers who asked such a question initially about what we can do to affect change, so I appreciate you addressing the question in such detail with this post. I also was unaware of this new donut hole proposal, and, as expected, am quite frustrated by it. A flat tax or progressive tax certainly seems like a more just system to me. Have you read any arguments as to how members from both parties are justifying the donut hole? Is it because their salaries all lie around the donut hole figures? Seems like it would benefit their demographic the most!

    I'd also like to see some type of reform on the self employment social security tax. I personally don't suffer from it, but my fiance gets destroyed by it every year. Self employed individuals already have to sustain their own health care, benefits, and vacation time. Tacking on extra social security tax at the current levels especially in lower income tax brackets makes it really challenging to stay afloat. I'm sure there's a million arguments against that too, but my is it frustrating witnessing it first hand!


    1. Hi Elise! Thanks for that comment and sorry for the late reply. Busy weekend. :)

      Glad to hear we're on the same page with a flat or progressive tax system instead of the dang doughnut hole that eventually becomes flat in a few decades.

      The arguments for the doughnut hole seem to be that it's incrementally better and achievable because it's so watered down that even some Republicans favor it. Which is just so gutless that I can barely stand it.

      I agree that the self employed seem to be at a disadvantage. I think perhaps copying the progressive structure and doubling it for the self employed (e.g. - the first $40k of business income is at a 0% rate) might be a step in the right direction.

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  11. You are wrong. SS is a progressive tax. First of all, while there is an upper limit on what is taxed, there is also a limit on payouts. Secondly, the amount of benefits earned is reduced as income increases (90%, 32% and 15%).

    1. I don't think you understand what a progressive tax system is.

      You're talking about how benefits are distributed, which is fine, but that has literally nothing to do with the system of taxation. How the government taxes is a separate issue from how it distributes benefits.

      Social Security taxes are undeniably regressive: the highest earners pay a lower percent in tax than the lowest earners. It's not a matter of opinion, it's just math. Please refer to the first chart in the post.