Can removing the tax cap save Social Security?

Abstract

AbstractThe maximum amount of earnings in a calendar year that can be taxed by Social Security is currently set at $118,500. In this paper, I examine if removing this cap can solve Social Security’s future budgetary problems. I find that when this cap is removed, benefits need to decline by less than 4% to keep Social Security solvent, compared to by almost 12% when the cap is held fixed at its current level. Households for whom the cap expires respond by working and saving less, which reduces labor supply, capital stock, and output, and also reverses some of the initial expansion in Social Security’s revenues. Elimination of the cap alters the pattern of redistribution implicit in Social Security, and also imposes larger distortions on labor supply and saving, which reduces overall welfare.