CEO’s see the benefit so early they never even notice it. For the very successful, the key date may have been in May or June. But for most very successful Americans, when the cool weather rolls in and the Christmas music starts, they have another reason to celebrate: their pay increases. Their employers haven’t decided to be extra generous in November or December, but their pay will step up by over 6% for a few weeks or months. The more you make, the longer your pay increases. Why does this happen? They exceed the Federal Insurance Corporation of America (Social Security) tax threshold.

For those not familiar with how Social Security payroll taxes work, workers pay 6.2% of their salary in FICA taxes up to an indexed threshold ($102,000 in 2008). Their employers pay a matching tax. When your salary exceeds that value, you and your employer don’t have to pay anymore. For the average American worker with a 2006 median salary of $33,634 this isn’t much of a concern, but for the best paid workers in our society, it’s a great benefit. Making $10K a month before taxes? Expect your pay to go up $600/month in November and December. Of course if you make that kind of money, an additional $1,200 might not mean much, but still it’s nice that the government is thinking of you.

The reality is that Social Security tax is tremendously regressive. There are no reductions to salary for Social Security tax purposes. No personal exemptions, no childcare deductions, no way to claim business expenses. A household with $65K/yr in salary and $20K in tax deductions can expect to pay more in Social Security taxes than income taxes. For the working poor, Social Security taxes may be the only payroll taxes they pay, but they pay at the same rate as someone making $100K/yr and at a higher rate than someone making more than that since the tax stops after the first $100,000. You can’t even combine incomes. Two income households may make more than the threshold combined, but the Social Security tax is levied on each salary. On the other hand, if you get your income from non-salary activities, you pay nothing. Flip houses for a living? No 6.2% tax on long or short term capital gains. Work in a factory? Pay up. Raking in the dividends? No Social Security taxes required. Independent operator like a contractor or physical therapist? Pay up twice since you have to make both your contribution and the employer contribution.

This system was justified by saying that the benefit you eventually receive from Social Security is somewhat proportional to the amount contributed. Those with higher incomes will receive more when they retire, but since the benefit is capped, the contribution should be capped as well. The fallacy in that argument is that Social Security is not a retirement program. It is an integral part of our social safety net that ensures that Americans who spent their lives contributing to our country will not be completely destitute in their declining years. There has been a lot of talk over the last few years about when Social Security will “run out of money.” Social Security funds have been commingled with general Treasury funds for years and the government will not let such a successful system fail, but there is an opportunity to reconfigure the Social Security tax system to improve fairness and ensure it is self funding. First, get rid of the income cap. This is not a retirement system, so stop treating it like it is. Second, move to a more progressive system on the tax rate. A fixed percentage may have been the best solution in 1935, but our existing pay systems can easily handle a slightly more complicated scheme that takes some of the burden off of our lowest paid citizens.

The Social Security program has been one of the most successful programs ever to be implemented in the United States. It hasn’t eliminated elderly poverty, but it has ensured that the majority of elderly Americans have some fallback position. That doesn’t mean it can’t be improved, but plans like Bush’s retirement savings accounts are the wrong way to go. Rather than pretending that Social Security is like a 401K, let’s admit that Social Security is a vital part of our national safety net and improve it from that standpoint to ensure that it remains well funded and operating for a long time to come.