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Monday, October 4, 2010

Social Security: Raising or Eliminating the Taxable Earnings Base

Janemarie Mulvey
Specialist in Aging and Income Security

Social Security taxes are levied on covered earnings up to a maximum level set each year. In 2010, this maximum—or what is referred to as the taxable earnings base—is $106,800. The taxable earnings base serves as both a cap on contributions and a cap on benefits. As a contribution base, it establishes the maximum amount of each worker’s earnings that is subject to the payroll tax. As a benefit base, it establishes the maximum amount of earnings used to calculate benefits.

Since 1982, the Social Security taxable earnings base has risen at the same rate as average wages in the economy. However, because of increasing earnings inequality, the percentage of covered earnings that are taxable has decreased from 90% in 1982 to 85% in 2005. The percentage of covered earnings that is taxable is projected to decline to about 83% for 2014 and later. Because the cap was indexed to the average growth in wages, the share of the population below the cap has remained relatively stable at roughly 94%. Of the 9.5 million Americans with earnings above the base, roughly 80% are men and only 9% had any earnings from self-employment income. New Jersey has the highest share of the population above the maximum (11.6%) and South Dakota has the lowest share (2.1%).

CRS estimated the potential impact of eliminating the taxable wage base on future benefits and taxes. If the base were removed in 2013, CRS estimates that by 2035, 21% of beneficiaries would have paid some additional payroll taxes over the course of their lifetimes. However, the average change in taxes and benefits would be small. Looking only at individuals who would pay any additional taxes over the course of their lifetimes, at the median, total lifetime tax payments would rise by 3% and benefits would increase by 2% relative to current law. In general, those in the highest income groups would have the largest changes in both tax payments and in benefits relative to current law.

Raising or eliminating the cap on wages that are subject to taxes could reduce the long-range deficit in the Social Security Trust Funds. For example, if the maximum taxable earnings amount had been raised in 2005 from $90,000 to $150,000—roughly the level needed to cover 90% of all earnings—it would have eliminated roughly 40% of the long-range shortfall in Social Security. If all earnings were subject to the payroll tax, but the base was retained for benefit calculations, the Social Security Trust Funds would remain solvent for the next 75 years. However, having different bases for contributions and benefits would weaken the traditional link between the taxes workers pay into the system and the benefits they receive.

Date of Report: September 24, 2010
Number of Pages: 27
Order Number: RL32896
Price: $29.95

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