In case you haven't noticed, Social Security is sort of a big deal in this country. Each month, almost 64 million beneficiaries receive a payout, with more than a third of these folks being lifted out of poverty as a direct result of their benefit. This is especially true for retired workers, where the elderly poverty rate would be more than four times higher than it is now if Social Security, as a program, did not exist.
However, this is also a dynamic program, with changes passed along every year.
Next year, for example, we'll witness an increase in the full retirement age for newly eligible retired workers, as well as see the cost-of-living adjustment (COLA) increase payouts for all current beneficiaries. Additionally, we'll also see an increase to Social Security's maximum taxable earnings cap. All of these changes are set to be announced in just five days, on Thursday, Oct. 10.
The maximum taxable earnings cap is a contentious subject
The latter change -- the payroll tax earnings cap -- is always of particular interest given the debate around whether or not the well-to-do should pay more into the Social Security program. You see, in 2019, all earned income between $0.01 and $132,900 is subject to Social Security's 12.4% payroll tax. By "earned income," I mean wages and salary, with all forms of investment income not included. All earned income above $132,900 is exempt from the payroll tax.
According to the Social Security Administration, 94% of working Americans earn less than the maximum taxable earnings cap -- meaning they're paying into the program on every dollar they earn. Meanwhile, the remaining 6% of workers who do earn more than $132,900 a year will have some or most of their earned income exempted from the payroll tax. More specifically, only 83% of all earned income is subject to the payroll tax, meaning 17% of all wages and salary -- about $1.2 trillion, as of 2016 -- was escaping the payroll tax. As of 2016, this was costing the program about $150 billion in lost revenue.
The fact that most working Americans are paying into Social Security with every dollar they earn while the well-to-do may only be paying into the program on a fraction of their income has some folks calling for an increase or elimination of the maximum taxable earnings cap.
What determines Social Security's payroll tax cap increase?
Despite strong support among the public for increasing or removing this cap, it's unlikely to happen. There's a clear division in Congress between Democrats and Republicans on how best to resolve Social Security's long-term cash shortfall, and the GOP is markedly against increased taxation on the rich as a sole solution.
However, the rich will still pay more into Social Security in 2020 than they did this year. That's because the maximum taxable earnings cap is tethered to the National Average Wage Index (NAWI). The tax cap increases in step with the NAWI on a percentage basis every single year a positive COLA is passed along to beneficiaries. In the rare instance where no COLA is passed along, which is the result of deflation, the payroll tax cap remains the same, even if the NAWI increases. When COLA again turns positive, the payroll tax earnings cap will play "catch-up" on the commensurate percentage increase.
For example, in 2017, the NAWI increased to $50,321.89, which marked a 3.5% increase from the previous year. In turn, Social Security's maximum taxable earnings cap rose by 3.5%, from $128,400 in 2018 to $132,900 in 2019.
As an additional example, in 2010 and 2011, no COLA was passed along to beneficiaries, thereby keeping the tax cap static at $106,800, despite increases in the NAWI. Once COLA turned positive in 2012, these increases over the previous two years and the current year were aggregated and accounted for in the tax cap increase.
Here's how much extra the rich could owe in Social Security tax next year
The big question, of course, is what the NAWI will look like for 2018 (which'll determine the 2020 payroll tax earnings cap increase).
In August, the Social Security Administration released its 2019 Facts and Figures report, which contains a bounty of information about the program's payouts and beneficiaries. Among the data, there's also a section discussing estimates on the 2018 NAWI.
Based on the report, the estimate (key word here) is for an increase of 2.9% to $51,794.15. That, in turn, would lead to a 2.9% increase to the maximum taxable earnings cap. Translation: The $132,900 cap in 2019 would increase to $136,800 in 2020.
How would this affect the rich? If they're self-employed or self-proprietors, they're going to be on the hook for the full 12.4% payroll tax. That means owing as much as $16,963.20 in full-year Social Security payroll tax next year. For those curious, that's an increase of almost $484 in 2020 from this year.
For well-to-do workers employed by someone else or a company, your employer covers half of your payroll tax liability. This means an increase of nearly $242 next year.
Even without congressional action, the rich will pay more into Social Security next year. All that's left to be decided is the precise amount of the NAWI increase, and therefore, the exact rise in the payroll tax earnings cap.