The Potential Impact of 2017's Social Security Cap

The amount of workers’ earnings that is subject to Social Security taxes is capped each year (called maximum taxable earnings), and the federal government  increased the Social Security cap significantly for 2017. For example, in 2016, the maximum earnings subject to Social Security taxes was $118,500. In 2017, the cap increased to $127,200, an increase of $8,700 or 7 percent. If your income exceeds that cap, you don’t pay Social Security tax on what you earn beyond the limit. The Social Security tax rate will remain unchanged at 6.2 percent. As a result of the cap increase, high-income workers will pay a few hundred more in Social Security taxes next year. Given that Social Security faces significant shortfalls that will make it impossible to pay out future benefits as promised without significant changes, will next year’s cap increase help Social Security last longer? Here is a look at the issues.

The coming year’s increase is higher than usual, even in light of last year’s lack of an increase. The table below shows the annual increases in the Social Security tax cap for the past 10 years.

Annual increases in the Social Security maximum taxable earnings, 2008–2017

Source: Social Security Administration annual notices of Social Security changes, 2008–2017.

 A worker who earned $127,200 in 2016 would have paid Social Security taxes of 6.2% on $118,500, or $7,347. His or her employer would have paid another $7,347 in Social Security taxes. If that individual is self-employed, the employer portion was his or her responsibility. (For more, see Social Security for the Self-Employed: How It Works.)

A worker who earns $127,200 in 2016 will pay Social Security taxes of 6.2% on all $127,200 of income, or $7,886.40, an increase of $539.40. His or her employer (or the individual, if self-employed) will match that higher amount.

While the Social Security tax burden appears to hit the self-employed much harder than it hits employees, the reality is that employers have to think of their share of the Social Security tax as part of employees’ earnings, which either increases their labor cost or requires them to lower what they pay out in salaries or wages.

As you’ve surely heard, the federal Social Security program that pays retirement, disability and survivors insurance benefits is in serious trouble. These benefits are paid out of two trust funds, the Old Age and Survivors Insurance (OASI) Trust Fund and the Disability Insurance (DI) Trust Fund. The combined trust funds held $2.8 trillion at the end of 2015 but are projected to run out of money in 2034, according to the summary of the 2016 annual reports from the Social Security and Medicare Board of Trustees. That’s just 18 years from now, soon enough to affect millions of current and future retirees.

Social Security benefits are paid out of the Social Security taxes collected from current workers and the interest payments it collects on the Treasury bonds it holds. In 2015, this income exceeded Social Security costs by $23 billion. After 2019, however, the government will have to start dipping into the trust funds to make up the shortfall between Social Security revenues and the benefits it pays out.

In 2034, when the trust fund is projected to run out of money, there won’t be enough funds to pay the number of projected retirees at current benefit rates. The large numbers of baby boomers entering retirement combined with a smaller number of people in the younger generations who are working and paying into Social Security is a major cause of the shortfall.  Whereas there were 3.2 workers to support every one retired beneficiary in 1975, today there are just 2.8 workers and in 2040 there may be just 2.1. In other words, the number of beneficiaries is increasing faster than the number of workers.  Still, the projected increase in Social Security spending is not as dramatic as you might expect: from 4.9% of GDP in 2016 to 6.3 pecent in 2046, according to the Congressional Budget Office. 

Social Security reform proposals aim to solve the shortfall. It is actually the DI Trust Fund that faces a more imminent crisis than the OASI Trust Fund, but since retirees are a much larger group than the disabled, the latter has received more press. Without Social Security reform, the Board of Trustees says expected tax income will be able to pay about three-fourths of expected benefits from 2034 on. 

Increasing the Social Security cap helps, but it does not solve the impending Social Security shortfall. The tax cap would actually have to be eliminated entirely to close a significant percentage of the Social Security gap, according to calculations by the Committee for a Responsible Federal Budget, a think tank that publicizes Social Security and other federal budget issues.

Even that drastic measure would be far from a complete fix. Truly solving the problem will require a combination of measures, such as higher Social Security taxes, lower benefits (perhaps only for the well-off) and indexing the retirement age to life expectancy. (For a look at  Social Security’s future, see Social Security Depletion: Is the Fear Justified? and How Secure Is Social Security?)