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Can Removing the Tax Cap Save Social Security?

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  • Shantanu Bagchi

    (Department of Economics, Towson University)

Abstract

The maximum amount of earnings in a calendar year that can be taxed by U.S. 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. Using a calibrated general-equilibrium life-cycle consumption model, I show that under a realistic longevity improvement, removing this cap leads to Social Security benefits declining by less than 3%, compared to almost 15% 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 also makes Social Security more progressive, which has positive insurance effects for households with unfavorable earnings histories, but the higher marginal tax rates impose larger distortions on households that are no longer subject to the cap, which reduces overall welfare.

Suggested Citation

  • Shantanu Bagchi, 2014. "Can Removing the Tax Cap Save Social Security?," Working Papers 2014-05, Towson University, Department of Economics, revised May 2016.
  • Handle: RePEc:tow:wpaper:2014-05
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    1. Can Removing the Tax Cap Save Social Security?
      by Christian Zimmermann in NEP-DGE blog on 2014-09-29 02:23:00

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    2. Eytan Sheshinski & Frank N. Caliendo, 2021. "Social Security and the increasing longevity gap," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 23(1), pages 29-52, February.

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    More about this item

    Keywords

    Social Security; tax cap; mortality risk; labor income risk; incomplete markets; general equilibrium.;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions

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