Obama’s “donut hole” Social Security solution

Barack Obama has come up with an intriguing solution to the social security funding crisis.

Right now, those with wage and salary incomes up to $102,000 pay full Social Security tax on their earnings. Earnings above $102,000 are Social Security-tax free. (These earnings also don’t count for determining later benefits).

The problem with this, of course, is that it has the effect of a regressive tax: essentially, you’re in a 6.2% (actually 12.4% counting employer contributions) “tax bracket” until you hit $102,000. Earnings above that are in the “zero” tax bracket.

The higher the threshold for the zero bracket, the more money the Social Security system takes in. Thus, it’s no surprise that the threshold is raised every year. Proposals aimed at increasing funding for Social Security often involve raising the it even higher, or eliminating it altogether.

Obama wants to tax higher incomes—but only those above $250,000. In other words, you’d pay on the first $102,000 you make, and on everything above $250,000. But income between $102,000 and $250,000 would not be taxed at all.

It’s an intriguing concept. People in the $100,000 to $250,000 represent the upper middle class, and percentage-wise, they bear by far the highest tax burdens of anyone. They earn enough to be in a high tax bracket, but they’re nowhere near rich enough to take real advantage of all the loopholes that benefit the ultra-rich, who typically don’t derive most of their incomes from salaries. Typical “rich person” sources of income, such as capital gains, dividends, and inheritances, are only taxed lightly, or not at all. Giving a special benefit to the most overtaxed segment of our society makes at least some sense.

Critics, however, wonder why the upper middle class should get a benefit when the lower middle class is being far more unfairly burdened—not by taxes, but by the cumulative effect of globalization, immigration of cheap labor, outsourcing, and downsizing. Also, the Obama proposal, if implemented, will only cover half of the looming shortfall in the Social Security budget.

If Obama is elected, it will be interesting to see if he pursues this further.