Implicit Taxes on Work from Social Security and Medicare

Abstract

Implicit taxes are present in many government programs and can create substantial work disincentives. The implicit tax created by Social Security is the payroll tax used to fund the retirement portion of Social Security minus the present value of the incremental retirement benefits associated with the earnings. While the payroll tax is always 10.6%, the implicit tax varies over a worker’s career because additional earnings translate nonlinearly into additional retirement benefits. We show that workers at the start of their careers experience lower implicit tax rates, as the increase in benefits from additional work is relatively large. However, workers who are closer to retirement earn little or no additional benefit from additional work. The main implicit tax in Medicare lies in the Medicare as Secondary Payer (MSP) policy, which requires Medicare to be a secondary payer for Medicare-eligible workers whose employers offer a health plan and have 20 or more employees. Thus, affected workers effectively forgo the Medicare benefits that they would have received if they had not been working. We investigate a combination of policies that can reduce average implicit tax rates on older workers by as much as 45%.