For High Earners, a Higher Limit?

For some 9 million upper-income U.S. workers, it's a welcome kick in the paycheck. At some point each year, their cumulative pay hits the limit set for earnings taxed for Social Security -- this year, $90,000. None of their earnings above the limit is subject to Social Security levies, so they take home hundreds of extra dollars every payday. A $150,000-a-year executive, for example, will max out this year's tax -- paying $5,580 on $90,000 in pay -- in early August and will then net an extra $775 a month.

Taxing high earners on more of their pay could go a long way toward filling Social Security's long-term funding gap -- and boost economic growth in the short run. But over time, a stiff tax hike on high-income workers could stall productivity and limit the economy's growth. "When you take from high-income savers and give to low-income consumers, you end up with less growth," says Mark M. Zandi, chief economist at Inc. in West Chester, Pa.

President George W. Bush has signaled that he'll accept a hike in the tax cap, but he hasn't said how high he'd go. Social Security's actuaries calculate that taxing all pay at today's 12.4% rate would close the system's $3.7 trillion funding gap for the next 75 years, with money left over. That works only if high earners' benefits are left unchanged. If the 6% of workers who would pay more get richer benefits in return, boosting taxes alone won't close the gap.

Few experts advocate making the $90,000-plus crowd pay full freight. "Such a heavy burden on high earners could make them view Social Security as a welfare plan and undermine its political support," says Brookings Institution economist Peter R. Orszag. He calls for a 3% tax on earnings above the cap. Other economists note that growing wage inequality has cut the share of pay subject to the payroll tax from 90% in the early 1980s to 85% now. Raising the cap to $146,000 this year would restore the old ratio -- and close 40% of the funding gap. Workers would pay as much as $3,472 extra, matched by employers.

But even moderate tax hikes could depress growth over Social Security's 75-year horizon. At first, higher taxes would bolster Social Security's Trust Fund, cutting the budget deficit, lowering interest rates, and spurring growth, Zandi says. But over decades those gains would be overwhelmed by higher taxes' impact on savings and work effort in the upper middle class. Conservative economists don't even see a short-term benefit, unless the higher revenues are diverted into individual savings accounts. "A new dollar in the Trust Fund only encourages Congress to spend $1 more," says Jeffrey R. Brown, an economist at the University of Illinois at Urbana-Champaign who served on Bush's 2001 Social Security commission.

Trouble is, somebody has to pay for the gap between Social Security's means and its promises. By putting the payroll-tax cap in play, Bush has all but guaranteed that higher earners will pick up a good chunk of the tab. The annual paycheck surprise could soon be a rarer treat.

By Mike McNamee in Washington

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