Work and Retirement

Policy Backgrounders | Social Security

No. 162
Friday, November 03, 2006
by Liqun Liu and Andrew J. Rettenmaier

Reducing Payroll Tax Payments for Social Security Beneficiaries

"The earnings test reduces the percentage of men earning more than the average wage."

High tax rates on labor income have reduced the overall labor supply below what is economically optimal. In addition to Social Security payroll taxes, direct and indirect levies on wages raise the combined marginal tax rate to more than 25 percent for the average worker. Since seniors are more responsive than younger workers to changes in the marginal tax rates on labor income, reducing their Social Security payroll tax rates would generate above-average increases in the hours they work.

Under current law, older workers will make substantial payroll tax payments in 2006:

  • The average 64-year-old worker is expected to earn $26,662 and pay an additional $2,826 in Old Age and Survivors Insurance (OASI) taxes.
  • Higher-earning individuals will make an estimated $42,643 and pay an additional $4,520 in taxes.
  • For individuals reaching the early retirement age this year, cumulative OASI taxes between 62 and 64 years will amount to over $9,000 for average earners and reach almost $15,000 for high earners.

"Reducing payroll taxes and eliminating the earnings test would increase the percentage of seniors who work."

When workers start claiming benefits, the Social Security taxes they pay on wages between ages 62 and the normal retirement age do not generate any additional Social Security benefits. To rectify this situation, their future benefits could be increased to account for the additional taxes they pay. But a simpler approach would be to eliminate or greatly reduce their payroll taxes. Estimates from one recent study imply that a 10.6 percent increase in wages from eliminating the OASI tax would increase work by older men by 2.39 percent to 3.35 percent.16

Combining a reduction in payroll taxes with elimination of the earnings test would increase the labor supply of older Americans. If seniors expect to spend longer periods in the labor force, they could be induced to earn higher wages in the years prior to retirement and, as a result, payroll tax collections would be larger. Further, income tax receipts from individuals who would have otherwise left the labor force or reduced their hours of work will rise, somewhat offsetting lower payroll tax revenues.17

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