Question

(c) Explain what would happen to the cash flows (benefits paid & FICA taxes received) of the Social Security system if the earnings threshold (currently $137,700) were raised dramatically? Focus separately on flows in and out, and on the short run and the long run.

Short run

Benefit payments made

FICA taxes received

Overall

Long run

Benefit payments made

FICA taxes received

Overall

(d) Explain how your answer to (c) highlights governance problems with the system & suggest how these could be corrected.

Answer 1

• Under the US Law, Federal Insurance Contribution Act is Compulsory towards social security is 6.2% of employee and 6.2% of employer.
• For example : Someone earning $50,000 will pay $3,825 of FICA contributions in 2019, broken down as $3,100 of Social Security tax, and $725 of Medicare. The person's employer would pay the same amount. There is no wage cap for medicare.

• A single person earning $250,000, on the other hand, will pay $12,305. The calculation of this second example is slightly more complex. The person will pay 6.2% of the first $132,900 earned for Social Security ($8,230), then 1.45% of the first $200,000 earned for Medicare ($2,900) and finally 2.35% of the $50,000 in income above $200,000 for Medicare ($1,175). In this last case, the employer would pay only $11,130, as it is not responsible for the additional 0.9% tax for an income of more than $200,000.

• In the given example hence if the earnings are more than threshold of $137700, the FICA Taxes would increase both in short run and long run and there would be favaourable impact on economy.

• Governance problems within the system is to ensure that all enterprises report the correct income. To correct this there should be online extraction of company accounts from company website. IN this way the FICA can be rest assured that Income is correctly reported.