A Progressive Payroll Tax 2 - Mid & Upper Wage Workers

A Progressive Payroll Tax 2 - Mid & Upper Wage Workers

My December 8, 2013 post discussed Tier One of the progressive payroll tax which offers a 3% rebate for workers/self-employed whose earnings for a calendar year do not exceed the federal minimum wage level equivalent for a full-time worker. The rebate is payable to workers, but not employers, upon filing a federal tax return and it does not in any manner change an employer’s requirement to withhold payroll taxes in the established manner.

Tier Two is the status quo. Payroll taxes and self-employment taxes will remain the same as they have been for a number of years. Here is a link which provides the Maximum Taxable Earnings since the Social Security program began: http://www.socialsecurity.gov/planners/maxtax.htm .

Tier Three will require employees and the self-employed to pay a higher FICA/SECA tax rate for a portion of their earnings. This higher rate applies only to the employee share and will not apply to the employer’s tax share. The maximum taxable earnings cap will not be scrapped.

While this sounds complicated, in this computer era its effectuation will be simple. Currently, employees pay a 7.65% tax which consists of 6.2% toward the Social Security trust fund and an additional 1.45% Medicare tax which is not subject to the maximum taxable earnings cap.

I am proposing that earnings “within” this new Tier Three zone will be taxed at a 8.2% rate (or a new total 9.65% rate). Thus, an employee will pay 7.65% (total) for a portion of their earnings that fall within Tier Two and 9.65% (total) for the remaining portion of their earnings which fall within the Tier Three zone.

The self-employed will be responsible to pay an additional 2% (not 4%) for all their earnings that fall within the Tier Three earnings zone.

Employers will be required to withhold this higher tax, but workers with multiple jobs may have to pay the additional required amounts via their federal income tax return if necessary.

How is Tier Three defined? As we have previously noted, the maximum taxable wage base increases yearly (or, as we noted in a prior post, the law should be changed so that it automatically increases each year). Upon enactment of the BEST Social Security Mod Plan, Tier Three will begin with the first Maximum Taxable Earnings increase after enactment and will continue for the following nine years for a total of ten years. Tier Three will consist of a rolling ten year zone where the cumulative amounts of increases in the Maximum Taxable Earnings wage base will be taxed at the higher 8.2%/9.65% rate.

Here is an example: The BEST plan is enacted into law in 2014. Let’s assume for simplicity sake that, in 2015 and for the next 11 years, the taxable wage base increases $3,000 each year.  The 2014 amount of $117,000 increases in 2015 to $120,000. The portion of all earnings greater than $117,000 will be subject to paying the 8.2%/9.65% rate. This is year one. 2016 will be year two. If the taxable wage base increases in 2016 to $123,000, all workers will pay 6.2%/7.65% for their wages up to $117,000 and the higher rate for wages over $117,000 up to $123,000. Each year the wage base increases and after ten years in 2024, a worker would be paying 6.2%/7.65% payroll tax for earnings up to $117,000, but 8.2%/9.65% for any amount of earnings between $117,000 and $147,000. Since Tier Three consists of a rolling ten year zone, in 2025, the wage base increases to $150,000 and an earlier year drops out and the portion of earnings subject to the higher 8.2%/9.65%  now fall in the zone between $120,000 and $150,000 thereby preserving a ten year Tier Three zone or range.

The Three Tier system will raise new trust fund revenues without increasing benefits and without scrapping the cap and without creating a situation where either benefit payouts will significantly increase due to drastically increased average earnings or the situation wherein high wage earners who are forced to pay unlimited increases in payroll taxes rise up in opposition to the Social Security program and program confidence is eroded.

A Progressive Payroll Tax 1 - Low Wage Workers

A Progressive Payroll Tax 1 - Low Wage Workers

The Social Security payroll tax (or FICA or SECA tax) is often referred to as a regressive tax. That is because even low wage workers or self-employed businesses are required to pay the tax even if the income level is so low that no federal income taxes are payable by these individuals.

Having to pay this mandatory tax is not necessarily a bad thing because paying the tax provides the workers with retirement, survivor, and disability coverage or insurance.

On the other hand, the formula which is used to determine the amount of Social Security benefits which are payable is a progressive formula in that low wage workers do receive a benefit which represents a higher percentage of their average wages. High average wage workers receive a lower percentage. This is because a person’s unreduced benefit amount is calculated using a three tier or bend point formula. These tier or bend points are different depending on the year a worker first become eligible for benefits.

For 2014, here is how it works. (Note that this is more complicated – so don’t try this at home! I’m only citing the information here to illustrate how the benefit amount formula and its progressive bend points or tiers work.) In 2014 the monthly benefit for a first eligible worker is the sum of the 3 following amounts:

1. 90% of the first $816 average, indexed monthly earnings

2. 32% of the earnings over $816 and up to $4917 average, indexed monthly earnings

3. 15% of any average, indexed monthly earnings over $4917.

Thus, a worker first eligible in 2014 whose average indexed earnings over their working career were $816 times 12 months or $9792 would receive a benefit, before any reductions, of 90% of this amount or $8812. All others whose average, indexed monthly earnings exceed the first bend point would receive a benefit that represents a lower percent than 90% of their average, indexed monthly earnings, with high average earners receiving the lowest percentage of their average, indexed monthly earnings.

The progressive benefit formula using the three tier system of bend points is a good thing, but it is not enough. The BEST Social Security Modernization Plan is also proposing that Social Security adopt a progressive three tier payroll tax system to make it less regressive for low wage workers. However, at the same time I am generally opposed to any sort of means testing for Social Security. Social Security benefits represent an earned right and means testing only serves to erode confidence in the very important Social Security program.

Here is how the payroll tax currently works for employees in 2014. An employee pays 6.2% into the Social Security trust fund plus an additional 1.45% Medicare tax. The 6.2% tax must be paid on all wages up the and including the 2014 payroll cap of $117,000. The 1.45% Medicare tax is not subject to the cap and must be paid on all wages. The employee’s employer pays a matching equal amount. Thus, the total amount paid into the Social Security trust fund is 12.4% payroll tax and 2.9% Medicare tax for a total of 15.3%.

The self-employed currently pay the equivalent tax of both the employee and the employer or 12.4% into the Social Security trust fund and 2.9% to the Medicare trust fund for a total of 15.3%.

Here is what I propose: All workers whose earnings for the entire year are the equivalent of the wages for a full time worker earning the federal minimum wage shall be eligible for a 3% rebate of the payroll taxes they paid for the year, refundable at the time a federal income tax return is filed for that year. The 2013 federal minimum wage is $7.25 an hour. Thus, for a 40 hour week for 52 weeks, this comes to $15,080. A 3% rebate could be as high $452.40.

The rebate is payable at the time a federal income tax return is filed. It is not means tested like the Earned Income Tax Credit (EITC). Anyone whose total earnings for the year do not exceed $15,080 would be eligible, including part-time workers, even if their hourly wage exceeds the minimum wage as long as their total combined wages and self-employment earning for the year are $15,080 or less and regardless of other income and resources. This annual amount will increase as the minimum wage increases.

The self-employed whose combined wage and self-employment earnings for the year are $15,080 will pay a 9.3% self employment tax rather than the usual 15.3% SECA tax rate.

The idea for this proposal predates the 2% payroll tax rebate, of 2011-2012, and it is possible that the 2% idea may have stemmed from The BEST Social Security Mod Plan’s many earlier publicity attempts. The “BEST” plan’s idea is better for 2 reasons: It is more progressive in that it provides a 3% tax reduction for lower wage workers, and since the money is only refundable upon filing a tax return, those who are eligible will receive a lump sum rather than a small weekly increase. Having $200-$400 to spend all at once could enable someone to make a much needed purchase and that spending might even boost the economy.

Who will tier one of the progressive payroll tax benefit? In addition to low wage workers, it could benefit struggling students who work part time or during the summer, retired seniors who work part time, or start up self-employed businesses. It would even benefit those with modest level of rental income or short-term capital gains who upon the new definitions of work will be required to contribute Social Security payroll taxes on their earnings.

It may particularly serve to boost confidence in the Social Security program of younger workers and students.

Where would the funds for this 3% rebate come from? It could come from the Social Security trust fund, but legislation could direct these refund amounts to be paid from general tax revenues, thereby boosting the Social Security trust fund. Keep in mind, these refunds will only be made if they are claimed via a federal tax return.

New Sources Of Revenue 2 - Rentals From Real Estate

New Sources Of Revenue 2 - Rentals From Real Estate

A second source of new revenue that the BEST Social Security Modernization Plan proposes to infuse additional funding into the Social Security trust fund is rental income from real estate.

Under current law rental income is taxable if one of three conditions is met: https://secure.ssa.gov/apps10/poms.nsf/lnx/0301803600 . The second of these three conditions is when “personal services” are provided as part of the rental agreement. These are defined here: https://secure.ssa.gov/apps10/poms.nsf/lnx/0301803624 .

I feel that those who rent real estate are working by way of their financial investment, their diligence, and their vigilance, in not only protecting their investment, but also in their quest to earn money via their investment. The current exception is admittedly rather arbitrary and all rentals should be subject to paying the SECA tax.

In fact, working and earning money via investments and rentals of real estate has become a very trendy way of working and earning a living, perhaps precisely because of the current Social Security tax exemption loophole.

Here are two articles which discuss “rents,” the best thing (?) since sliced bread: http://www.opednews.com/articles/1/Rent-is-50-of-a-Nation-s-by-Fred-Harrison-Money_National-Debt_Reform_Taxes-131124-761.html , and  http://www.alternet.org/economy/tomdispatch-laura-gottesdiener-wall-streets-rental-empire?paging=off&current_page=1#bookmark .

Now once the law is changed to remove the exception to Social Security coverage rentals from real estate is it a fairly straightforward process to collect the tax from the self-employed: http://www.irs.gov/taxtopics/tc554.html . However, if even the same individual is incorporated how do we collect the “compulsory” Social Security tax? In fact, has Social Security been collecting the compulsory tax from those landlords who have been performing personal services if those landlords are incorporated? I do not think so. While a corporation may require an employee to be paid a salary, the additional net income from real estate rentals should also be subject to the FICA/SECA tax.

This is why I want a seat at the table when Social Security is reformed. I propose that net earnings from rentals from real estate be subject to the 12.4 per cent Social Security tax. This tax should be compulsory and the monies should be credited to the Social Security trust fund. The 12.4% could be a deduction from corporate earning subject to income taxes, but it should not reduce the net earnings from real estate. If the landlords pass on the SECA tax to renters, then the added pass along amount will increase the net rental income thereby causing a further increase to the amount of Social Security taxes payable.

This newly proposed Social Security tax differs from currently existing taxes as the money paid into the Social Security trust fund will not be credited to any individual, but it will boost Social Security trust fund solvency. Keep in mind that Social Security is a social insurance program where shared contributions proved retirement, survivor, and disability insurance to all participants. It is not that unlike the situation of am unmarried worker, without children or dependent parents, who works and pays into the trust fund right up to her/his untimely death before age 62. No benefits ever are paid to anyone on this worker’s account. Yet, her/his contributions served to keep the program solvent.

However, if we can all agree that earning from real estate should be subject to Social Security taxation, then we should be able to collect that tax regardless of whether these earnings are from the self-employed or a corporate structure.

In addition to being a new source of revenue for the Social Security trust fund, there is another reason why making rental income and stock market gains and capital gains subject to Social Security taxation will make the trust fund solvent: persons or corporations generally receive these types of income for longer periods of time than the typical worker. Monthly Social Security retirement benefits are calculated by using the worker’s highest 35 years of earnings after they are indexed for inflation. A typical worker might have 40 years where they pay into the Social Security trust funds. Thus Social Security collects Social Security taxes for an extra 5 years which do not affect the worker’s benefits at all. This benefits the trust fund. The worker who has rental income, stock market gains, or capital gains may have, for example, 55 years of creditable earnings. Yet, only 35 years affect the worker’s benefits. In this case rather than having an extra 5 years to boost the trust funds, there will be 20 years of additional tax receipts to keep Social Security solvent.

Update: Some may wonder, what about the old venerable owner-occupied duplex? I’m not in favor of modernizing Social Security by adding exceptions to coverage. However, a realistic compromise might be to exclude owner-occupied rental income for duplexes only, beginning with the year in which the owner reaches full retirement age, which is currently age 66 but is scheduled to top out at age 67 in the future.