81 Years of Social Security's Maximum Taxable Earnings in 1 Chart

By Sean Williams Markets Fool.com


Image source: Getty Images.

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Social Security income is vital to the financial well-being of a majority of seniors during retirement. Data from the Social Security Administration shows that better than three in five retired workers rely on their Social Security benefits for at least half of their monthly income during retirement. This means the well-being of Social Security is among the most paramount priorities of Congress.

How Social Security is funded

The Social Security program is itself funded in three ways: payroll taxes, interest, and the taxation of benefits.

Working our way backwards, the taxation of Social Security benefits makes up the smallest percentage of revenue (3.4% as of 2015). According to The Senior Citizens League, in excess of half of all households with retired workers who are currently receiving Social Security benefits owes at least some tax to the federal government on a percentage of their benefits. This is a result of the tax thresholds associated with the taxation of benefits not adjusting for inflation over the past 34 years.

The interest earned on the more than $2.8 trillion in spare cash currently held in the Social Security Trust in special issue bonds and certificates of indebtedness generated 10.1% of the programs' revenue in 2015. If this spare cash were to dwindle, as is expected over the next two decades according to the Social Security Board of Trustees' 2016 report, interest income to the program could diminish or disappear entirely.

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By far, the largest contributor to Social Security's annual revenue is the payroll tax -- a 12.4% tax on working wages that's often split down the middle between employers and employees (i.e., 6.2% each). The payroll tax generated 86.4% of all revenue for the program in 2015.


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The 81-year history of Social Security's payroll tax

In 2017, the payroll tax applies to all wages earned between $0.01 and $127,200, which essentially means that more than 90% of all working Americans are paying into Social Security with every dollar they earn. Any wages earned above and beyond $127,200 is free and clear of the payroll tax.

The reason the maximum taxable earnings level exists in the first place is because there's also a maximum monthly benefit under Social Security when retired. It wouldn't make sense to have someone pay 6.2% on $50 million in annual wage income but receive a maximum monthly payout at full retirement age of just $2,687 as of 2017.

Today, the maximum taxable earnings figure of the payroll tax is determined by the National Average Wage Index. In simpler terms, this means that the upper bound of what's taxable increases on par with wages. If the National Average Wage Index rises by 3%, the maximum taxable earnings boundary on the upper end rises by 3%.

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The one caveat would be in years where no cost-of-living adjustment (COLA) is given to seniors. If the Consumer Price Index for Urban Wage Earners and Clerical Workers falls on a year-over-year basis, then no COLA is given to Social Security recipients, meaning their benefits stay the same. In such an instance, the maximum taxable earnings figure remains the same as well. However, once there is a positive COLA for beneficiaries and they get a "raise," the maximum taxable earnings figure plays catch-up with all previous years where there wasn't an increase. That's why the payroll earnings tax cap rose by more than 7% in 2017 to $127,200 from $118,500 in 2016.

However, Social Security's payroll tax cap wasn't always wage-indexed. Generally speaking, wage-indexing has been the norm since about 1975. Between 1937 and 1971, the payroll tax cap was increased on an ad hoc basis. Essentially, the cap was increased when Congress felt that retirees needed a raise and the program needed more revenue. It was completely arbitrary. Between 1972 and 1974, the maximum taxable earnings were determined by amendments passed in 1972.

To get a better feel for how Social Security's maximum taxable earnings have grown throughout the years, here's an 81-year chart showing its progression:


Data source: Social Security Administration. Chart by author.

A highly contested topic

Since the payroll tax plays such a vital role in funding Social Security, it's also the center of a highly contested debate: whether the wealthy should pay more.

As noted above, there is a monthly maximum benefit payable at full retirement age of $2,687. This figure tends to adjust with inflation on an annual basis. Some lawmakers would contend that the wealthy have little or no need for Social Security income in the first place, and thus they should pay the payroll tax on income above and beyond $127,200.

For those who may not recall, raising the payroll tax earnings cap was an idea that Hillary Clinton had proposed during her presidential campaign. Clinton had suggested providing a moratorium on payroll taxes between the wage-indexed taxable earnings level and, say, $250,000 and then reinstituting the 12.4% tax on all wages in excess of $250,000. Some pundits have even suggested lifting the cap altogether and taxing all wages at 12.4%.

Image source: Getty Images.

On one hand, requiring the rich to pay more into Social Security could substantially reduce the expected budgetary shortfall in Social Security. At worst, it would extend the length of time for Social Security to exhaust its spare cash, at which point benefit cuts would be needed to sustain the program for future generations. It's also an extremely popular measure since raising the payroll earnings tax cap would affect fewer than one in 10 Americans.

The other side of the equation is that it's not particularly fair to the wealthy to require them to pay more into the system when they're not getting commensurate returns back. Social Security benefits are based on your average monthly income over your 35 highest-earning years. However, Social Security caps the value of your annual earnings since there's a monthly maximum benefit. If the wealthy have to suddenly pay a lot extra into Social Security, they're not necessarily going to see a dime in extra benefits once they retire.

With Trump and Republicans firmly in control of the legislative branches, it seems highly unlikely that the payroll tax earnings cap will be tinkered with anytime soon. But I also wouldn't suggest that raising Social Security maximum taxable earnings is off the table for good, either.

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