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Can Removing the Tax Cap Save Social Security?

Listed author(s):
  • Shantanu Bagchi

    ()

    (Department of Economics, Towson University)

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.

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File URL: http://webapps.towson.edu/cbe/economics/workingpapers/2014-05.pdf
File Function: First version, 2014
Download Restriction: no

Paper provided by Towson University, Department of Economics in its series Working Papers with number 2014-05.

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Length: 27 pages
Date of creation: Sep 2014
Date of revision: May 2016
Handle: RePEc:tow:wpaper:2014-05
Contact details of provider: Postal:
Towson, Maryland 21252-0001

Phone: 410-704-2959
Fax: 410-704-3424
Web page: http://www.towson.edu/cbe/departments/economics/

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