Here's an idea whose time may be coming: Take the cap off the payroll tax. Apply the payroll tax to every dime of Fat Cat income.

Many readers have suggested this since the big tax cut last year.  They see it as a response to the excess of top corporate executives. They also see it as a possible solution to the long term funding of Social Security retirement and disability benefits.

What really got my attention, however, was a spreadsheet sent by "GFS", a reader. A CPA, he took a Forbes magazine list of the ten highest paid executives in America for 2003. Then he calculated how much they would have paid in additional payroll taxes if the "wage base maximum"---what Social Security calls the limit--- hadn't been $87,000.

The ten executives would have paid an additional $73.1 million in payroll taxes.

Kind of gets your attention, doesn't it?

Jeffrey C. Barbakow, former CEO of Tenet Healthcare, paid only $10,788 in payroll taxes for retirement and disability in spite of being the top paid exec in America at $116,683,000. This happens because the non-Medicare portion of the employment tax was capped at $87,000 in 2003. Every dollar over the cap pays the 2.9 percent employee/employer Medicare tax but escapes the 12.4 percent employee/employer Social Security tax. As a consequence, 99.999 percent of his compensation wasn't subject to the full payroll tax. His tax bill would have been $14,457,904 higher.

Maurice R. Greenberg, CEO of American International Group, was number ten with compensation of $29.3 million. His tax bill would have been $3.6 million higher.

These figures are sensational. But the number of people who earn such incredible sums is very small. Most people would be surprised at how quickly the air thins when you talk paychecks. Only 7 percent of all workers, for instance, earn more than the Social Security wage base maximum--- $87,900 for 2004.

To get an idea of the true potential, I went to www.ssa.gov and downloaded a copy of the Social Security Trustees report for 2004. The report, 216 pages that you won't want to read at the beach, is the second most frightening government document you can read. (The most frightening government document you can read is by the same authors: it's their 215-page report on the condition of Medicare.)

On page 105 we learn that the portion of all wages that escapes the payroll tax has varied quite a bit in recent years. The trustees estimate that 86 percent of all wages were subject to the payroll tax in 2003. The figure has been as high as 90.2 percent in 1983 and as low as 83.3 percent in 2000. "At least some of this decline and subsequent increase is believed to be due to stock option activity surrounding the stock market bubble in 2000 and is not likely to recur," they observe with the sly wit of actuaries. Long-term, they project that 83.4 percent of all wages will be subject to the payroll tax.

Flipping back to page 13 we find that they estimate the current payroll tax scheme will deliver an income rate of 13.84 percent of taxable payroll. Benefit costs, meanwhile, will be 15.73 percent of taxable payroll.

That leaves an unfunded gap of 1.89 percent over the next 75 years. This gap can be filled (they tell us on page 3) by:

1)  Immediately increasing the payroll tax by 1.89 percentage points,

2)  An immediate and permanent retirement benefit cut of 12.6 percent,

3)  Or by having an unnamed benefactor (possibly the Tooth Fairy?) deliver $3.7 trillion to the U.S. Treasury, tonight.

So far, both the Republicans and the Democrats prefer the Tooth Fairy solution because they won't talk about increasing the payroll tax or cutting benefits.

But wait a minute.

If only 83.4 percent of all wage income is taxed and it yields 13.84 percent of taxable payroll, allowing all wage income to be taxed could bring the yield up to 16.59 percent  (13.84 divided by 0.834) of taxable payroll. That's more than the 15.73 percent required--- so extending the payroll tax could avoid a cut in benefits for retirees or an increase in payroll taxes for working stiffs!

Would it work?

Probably not. While only about 7 percent of all workers would be affected, those earning $90,000 probably don't consider themselves under-taxed Fat Cats. Millions of these just-over-the-cap workers would be affected. More important, workers at the very top often have choices about when and how they receive their compensation. Much of today's highest wage income could, virtually overnight, turn into tomorrow's dividends, taxed at 15 percent and not subject to payroll taxes.

Taxes could be increased, but the income that was supposed to be taxed would magically disappear.

On the web:

Forbes ranking of CEO compensation

Social Security Trustees Report for 2004