The Social Security tax rate was scheduled to revert to its normal rate of 6.2% for employees on January 1, 2012, ending a year-long temporary reduction in the rate to 4.2%. Whether this rate should revert to its normal rate or remain temporarily reduced become the topic of intense political discussion. In one of the last legislative acts of the year, Congress passed and President Obama on December 23, 2011, signed into law the Temporary Payroll Tax Cut Continuation Act of 2011 (HR 3765). This legislation provides that the tax rate paid by employees for Social Security remains at 4.2% through the end of February. Employers still pay the full 6.2% rate for their portion of Social Security.
The President and various legislators indicated they will push for legislation to keep the employee-portion of Social Security taxes at 4.2% for the remainder of 2012. But achieving consensus in Congress on this issue may prove difficult. As the New York Times reports:
"Under growing political pressure, House Republican leaders accepted the two-month extension of payroll tax relief. But many rank-and-file members of the House Republican caucus said they doubted that the tax break would do much to stimulate the economy and saw no urgent need to continue it for 10 more months. By contrast, Mr. Obama and Congressional Democrats say the payroll tax cut is needed to bolster the economy."
There's two technical provisions in the two-month rate reduction in the Social Security tax.
Offsetting provision for higher income people. If an employee earns over $18,350 during the first two months of 2012, then those earnings will attract a 2% surtax, called a recapture of excess benefit in HR 3765. But such a surtax does not presently exist, and the IRS has stated, "This additional recapture tax is an add-on to income tax liability that the employee would otherwise pay for 2012 and is not subject to reduction by credits or deductions. The recapture tax would be payable in 2013 when the employee files his or her income tax return for the 2012 tax year." The provision for a recapture tax could be eliminated if Congress agrees to extend the tax rate reduction through the rest of 2012.
Provisions for self-employed persons. Self-employed individuals are also subject to the recapture tax if they have both self-employed earnings and wage earnings in the first two months of 2012, and their earnings exceed $18,350. We have yet to learn whether self-employed persons will need to keep track of their earnings on a monthly basis in order to determine how much self-employment tax they will need to pay.
IRS issues guidance for payroll procedures. Payroll processors and employers may need some time to implement the Social Security tax rate reduction. The IRS says that employers should implement the 4.2% rate on employee's contributions to Social Security no later than January 31, 2012, and any excess amounts withheld should be refunded to employees no later than March 31, 2012. (IR-2011-124) The IRS also said they will be revising the payroll tax forms and instructions.
Extending the payroll tax cut is not a real solution nor does it help sustain Social Security. There are a number of other options for making Social Security a sustainable program and for reducing the deficit. Progressive price indexing would substantially reduce the long-run funding gap to $3.2 trillion from the current law funding gap of $16.1 trillion. Thus, it would only require a modest solvency tax increase equal to 0.6% of taxable payroll. In terms of long-run spending, it would result in the second smallest program, about 82 percent of the size of the current program. Also, changing the benefit formula for SS would essentially eliminate the long-run funding gap and require no additional solvency tax. It also would produce the most dramatic reduction in spending on benefits, equal to 23% of long-run spending under the current benefit formula. In addition, it would retain the progressive nature of the benefit formula, but reduces the degree of progressivity relative to the current formula. Furthermore, raising the retirement age would reduce Social Security’s unfunded obligations for retiree benefits to $6.3 trillion and require a solvency tax of 1.3% of taxable payroll. It would result in the third-largest program, with about 87% of the current law spending. Moreover, though the distribution of net taxes would still be progressive, of the four potential changes considered it would reduce the degree of progressivity the most relative to current law. Finally, eliminating the taxable maximum would reduce Social Security’s unfunded obligation for retiree benefits to $8.3 trillion and require a 1.3% payroll tax increase. It would result in the largest program in terms of long-run spending, and would increase the progressivity of the program.
Carly, thanks for sharing your thoughts. I edited your comment to remove the URL that pointed to a PDF download. You are welcome to post a URL pointing to a Web page that describes the PDF file to be downloaded.