Arguments For and Against the Social Security Tax Cap

Proponents of increasing or eliminating the limit on earnings subject to the Social Security payroll tax argue that it would make the tax less regressive and be part of a solution to strengthen the Social Security trust funds. An analysis from the Congressional Budget Office estimated that phasing out the tax cap by subjecting earnings below the current taxable maximum and above $250,000, would have raised over $1 trillion in revenues from 2023 through 2032. Another argument is that removing the taxable maximum would adjust for the fact that higher-income individuals generally have longer life expectancies and thus receive Social Security benefits for a greater amount of time.

Opponents argue that increasing or removing the taxable maximum would weaken the link between the amount individuals pay in Social Security taxes and the amount they receive in retirement benefits. Opponents also contend that while low-income earners may pay a greater share of their income in Social Security taxes than those who are wealthier, they also receive a disproportionate share of government transfer payments that are not subject to the tax. Those opponents cite programs that have been created to — at least partially — offset the regressive nature of the Social Security payroll tax.

Some economists anticipate that if the limit were lifted, employers might respond by shifting taxable compensation to a form of compensation that is taxed at a lower rate. For example, employers could decrease wages but increase retirement benefits, which are deductible under the corporate income tax, in an effort to offset the additional payroll taxes they would owe.

What Is the Medicare Payroll Tax?

Employees and employers each contribute 1.45 percent of earnings by workers to Medicare, which is levied on all income. Since 2013, an additional 0.9 percent tax has been imposed on employees with earnings exceeding a threshold between $125,000 and $250,000 depending on filing status; those additional taxes are not matched by the employer.

The revenue from payroll taxes help fund Medicare’s Hospital Insurance (HI) program, which is used to pay for hospital stays and a few forms of home healthcare, such as hospice care. For 2022, HI tax revenues were 1.2 percent of GDP, an amount that has been relatively constant for 25 years. The HI tax was originally the primary source of revenues for Medicare before the program grew to include Medicare Advantage plans and prescription drug coverage. The taxes dedicated to HI now make up 78 percent of Medicare’s total inflows, a share that is projected to decrease going forward.

Are There Other Federal Payroll Taxes?

In addition to FICA or SECA taxes, a few other payroll taxes are levied on certain employees:

• Federal Unemployment Tax Act (FUTA) taxes are only paid by employers, at a rate of 6 percent for the first $7,000 of earned income per employee. FUTA taxes support funding for state-administered unemployment insurance programs.
• Railroad Retirement Act taxes are paid by railroad employees and employers to fund retirement programs for railroad workers.
• Other payroll taxes are mostly comprised of taxes paid by federal employees to fund their own retirement programs.

How Do Payroll Taxes Work in Other Countries?

Many countries in the Organization for Economic Co-operation and Development (OECD), a group of nations with high-income economies, also fund their social insurance programs with payroll taxes. While the Social Security systems of other countries take different forms, most provide government-financed pensions that provide income assistance for retirees, similar to that of the United States.

Despite that similarity, there is much variation in how other OECD countries impose payroll taxes on their citizens. Countries such as the Netherlands, Sweden, Germany, and Canada have caps on taxable earnings that are lower than in the United States; others, such as Norway and Ireland, tax all earnings. Generally, countries with higher payroll tax rates have lower caps, while countries with lower payroll tax rates, like the United States, tend to have higher caps or no caps at all. In some OECD countries, social insurance programs are funded through other sources such as income taxes or excise taxes.

Certain countries, like the United Kingdom and Austria, have a bracketed payroll tax structure that levies the payroll tax at different rates depending on total income, similar to how the United States levies income taxes. In the United Kingdom, that bracketed system is regressive in structure, while in Austria it is progressive.