A RBC reader named Mike M. just taught me several things about the Social Security tax. While I have published in the Journal of Public Economics, I didn’t know the details of the 2012 Social Security tax. Until I read these details about the non-linear taxation, I was unaware that the maximum taxable earnings cap is set at $110,100. So, permit me to do some algebra and then I will make a progressive tax point. Consider Mr. A and Mr B. Mr. A earns $110,100 while Mr. B. earns $220,200. Given the Social Security tax rate of 4.2% and given current rules, they both pay $4624.2 per year to Social Security and their employer pays 6.2% or $6826.2 per year to Social Security. This would appear to be a superstar subsidy. Suppose that UCLA must choose between hiring a $500,000 Nobel Laureate or 5 Assistant Professors. If I’m reading these rules correctly, UCLA would face a choice between paying $6826.2 per year for the Laureate’s Social Security or a rough total of $30,000 for the 5 rookies. That’s what I meant by the “Superstar Subsidy”.
What would happen to the Social Security System’s stream of revenue if the tax rate was cut to 4% but there was no cap? I think that revenue would rise sharply, I don’t see what unintended consequence would be triggered and I would support this policy change. I do see that firms who used to face a zero marginal tax on employees making over $110,000 might reduce their hiring of this group but this is an empirical question that merits research. Who is at the margin? Facing a 6.2% marginal rate on such $110,000 workers who would demand fewer and how many fewer jobs?