Monday, October 30, 2006

social security explained

I recently wrote two posts about taxes covering the AMT and tax withholding. A third element of our tax system is social security.

The table to the right shows social security costs during my earnings lifetime, from 1990 forward. During this time frame the cost of social security taxes has gone up significantly.

The annual rate for social security has gone up 90% from the period 1990 - 2007 at all wages up to the "earnings base" and it has increased 126% at two times the "earnings base".
Here is a brief primer on how the social security tax system works:

1) you have an "earnings base" component. This component increases every year. Up to this "earnings base", every dollar you make is taxed at the same rate. The earnings base started at $51,300 in 1990 and is now at $97,000 in 2007
2) this rate has 2 components - a FICA rate (social security) and a medicare rate. For the period 1990 - 2007 both of these RATES have been constant at 6.2% and 1.45%, meaning that you are paying a consolidated rate of 7.65% on every dollar from $1 up to your "earnings base" (currently $97,500 for 2007). Note that prior to 1990 this rate was considerably lower, so your parents did not pay in at this rate. If you made $97,000 and worked for a company, you would pay $7,459 in social security taxes in 2007
3) your employer pays social security taxes at the exact same rate that you pay. Thus at the "earnings base" for 2007 your employer would also be paying $7,459, for a combined total of $14,918. Don't think for one second that your employer isn't aware of these taxes and that they are not a concern to you; these taxes significantly impact the cost of hiring and are not a "free ride"
4) if you are self employed - you pay BOTH sides of social security, totalling $14,918. There are some other tax implications of this that I won't go into here that make this more complex
5) in 1994 congress passed another "stealth" tax increase - the 1.45% of the tax that is supposed to go to medicare (I say "supposed to" because really this is just general tax revenues) is no longer capped at your earnings base - it goes up to infinity. Thus for someone at 2x the earnings base, your maximum tax is $8,873 and with the employer portion (or your portion, if you are self employed) this increases to $17,745 a year using 2007 rate tables

As you retire, you receive benefits from social security, and health benefits in the form of medicare. I won't go into the details of these benefits because I don't have any direct knowledge on the topic - I am sure I will research them more as I move closer to retirement, as will all of us.

Social security revenues go into the coffers of the Federal government and are used to pay for Federal programs. An "IOU" goes into the social security trust fund as the government takes this money and spends it (not invests it) on whatever earmarks and programs that they desire. I won't go into the philosophy of everything but there is no "free lunch" - the government is spending this money today and "promising" to pay it back to you in the future, out of someone else's tax dollars. A large part of our budget deficit on all other programs today is offset by the fact that the government brings in about $200 billion dollars more on social security than it pays out each year.

Thus when you look at the totality of our tax system social security is a giant part of our current payments to the government. As an individual, you should take the time to add up:

- what you pay IN to social security and medicare
- what your employer pays IN to social security and medicare
- what you pay in local property taxes
- what you pay in local sales taxes (if applicable to your area)
- what you pay in state taxes (if applicable to your state)
- what you pay in Federal taxes (directly)
- what the company you works for pays in Federal, state, sales and local taxes

It is important that you are an educated person when it comes to taxes because without a proper understanding of taxes you will not be able to make informed financial decisions. All of these taxes, and the huge "compliance costs" of dealing with these taxes and overlapping government jurisdictions, comprise a huge burden on business that limits job and wealth creation. That is a fact.

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