Tax All Salary Reduction Plans
Employees now pay Social Security and Medicare payroll taxes on their contributions to tax-preferred employer-sponsored retirement accounts, such as 401(k) plans. They don’t, however, pay these payroll taxes on their contributions to some other types of benefit plans at work, like Flexible Spending Accounts. Collecting payroll taxes on contributions to all such benefit plans would increase the Social Security program’s funds, as well as increase the earnings used to calculate the Social Security benefits of workers who have those benefit plans. If you contributed $2,000 to a Flexible Spending Account, you and your employer would pay the 6.2 percent payroll tax (or $124 each) on that money. Taxing these salary reduction plans for Social Security the same way we tax contributions to 401(k) plans is estimated to fill 10 percent of the funding gap.
PRO: Congress should complete a reform it launched in 1983 when it treated workers’ contributions to 401(k) salary reduction plans as earnings that are taxed and counted toward Social Security benefits. Extending the same treatment to other such plans would be consistent, it would ensure workers that all of their earnings will count toward their future Social Security benefits, and it would reduce the Social Security funding gap. (Virginia Reno, National Academy of Social Insurance)
CON: This would be a case of robbing Peter to pay Paul. Changing the tax treatment of salary reduction plans would increase the cost of health care and other employee benefits because the tax savings help to offset the employer’s cost of operating the plans. The result would be fewer employers that are willing to offer these types of benefits. Individual workers would either have to buy these benefits themselves or to do without. (David John, Heritage Foundation)