Why is there a cap on the Federal Insurance Contribution (FICA) tax?
Social Security and Medicare payroll withholding are collected as the Federal Insurance Contributions Act (FICA) tax. 12.4% of earned income up to an annual limit must be paid into Social Security, and an additional 2.9% must be paid into Medicare. If you are a waged or salaried employee, half of the payroll tax - 6.2% for Social Security and 1.45% for Medicare - is automatically withheld from each paycheck, and your employer contributes the other half. If you are self-employed, you are responsible for the entire amount (12.4% for Social Security plus 2.9% for Medicare), but you can generally deduct half of the FICA tax on your federal income tax return.
There is no income cap (or wage base limit) for the Medicare portion of the tax, meaning you continue to owe your half of the 2.9% tax on all wages earned for the year. The Social Security tax, however, has a wage base limit - the maximum wage that is subject to the tax for that year. For earnings in 2014, the wage base is $117,000. That means up to $7,254 can be withheld from your paycheck for Social Security taxes - but not more, regardless of how much you earned.
When President Roosevelt presented his plan for Social Security, it did not include an income cap. The original plan exempted high earners from Social Security altogether - including both taxes and benefits - and anyone who made more than $3,000 a year (about $52,000 in 2014 dollars) was supposed to be left out of the system completely. As FDR's plan worked its way through Congress, the exemption for high earners was eliminated, and the House Ways and Means Committee replaced it with a $3,000 cap. Historians on the subject have found no evidence supporting why the committee chose an earnings cap over an exemption, but it has been in place ever since. Since 1982, it has risen at the same rate as wages in the economy.
The cap on wages subject to the tax is the subject of controversy, in part because it means that while most workers pay the tax on every dollar of their income (because the vast majority of workers earn less than the wage base limit), the highest earners pay tax on only a part of their income. Proponents state that lifting the cap would result in a significant amount of revenue that could help cover the shortfall Social Security will soon face, while opponents claim it would result in one of the largest tax increases of all time.
The Social Security Administration (SSA) announced that the maximum amount of wages in 2017 subject to the 6.2% Social Security tax (old age, survivor, and disability insurance) will rise from $118,500 to $127,200, an increase of more than 7%. By comparison, the 2016 wage base was unchanged from 2015.
The maximum amount of Social Security tax a taxpayer could pay will therefore increase from $7,347 in 2016 to $7,886.40 in 2017, an increase of $539.40.
The SSA also announced that Social Security beneficiaries will get a 0.3% increase in benefits in 2017, after receiving no increase in 2016. The average retiree will receive an increase of $5 a month.