Fundera. What Are Payroll Taxes? (2019)
Payroll taxes are any taxes that are withheld from or calculated as a percentage of an employee’s wages. This includes federal and state income tax withholding, social security and medicare taxes, federal and state unemployment taxes, and state and local payroll taxes. Most payroll tax revenue is used to administer government benefit programs.
AARP Public Policy Institute. Option: Increase the Payroll Tax Rate (2012)
Employers and employees each currently pay a 6.2 percent tax to Social Security on earnings up to $110,100. Self-employed workers pay both the employer and employee share, for a total of 12.4 percent. One option to help close the Social Security funding gap would raise the payroll tax rate for all workers and employers. For instance, on a $50,000 annual salary, increasing the payroll tax rate to 6.45 percent would increase both the annual employee and employer contribution by $125 each. Changing it to 7.2 percent would increase the annual employee and employer contribution by $500 each. The rate increase could occur gradually or all at once. Increasing the payroll tax rate from 6.2 percent to 6.45 percent immediately is estimated to fill 22 percent of the funding gap. Increasing the payroll tax rate gradually over 20 years on employers and employees from 6.2 percent to 7.2 percent is estimated to fill 64 percent of the funding gap.
Center for Budget and Policy Priorities. Increasing Payroll Taxes Would Strengthen Social Security (2016)
This paper presents three approaches to increasing payroll taxes that would improve the program’s solvency:
- Increasing or eliminating Social Security’s cap on taxable wages, now $118,500 a year. Raising the cap would help mitigate the erosion of Social Security’s payroll tax base caused by rising wage inequality. Most workers’ taxes would not change, while the degree of increase in high earners’ taxes would depend on whether the cap were raised or eliminated. Raising the tax cap could increase higher earners’ benefits as well, depending on how policymakers treated newly taxed earnings. Changes to the tax cap could close roughly a quarter to nearly nine-tenths of Social Security’s solvency gap, depending on how they were structured.
- Expanding compensation subject to Social Security payroll taxes to include fringe benefits such as employer-sponsored health insurance and flexible spending accounts. Fringe benefits are a growing slice of compensation, and including them in Social Security’s tax base would eliminate the discrepancy between those who receive fringe benefits and those who don’t. Affected workers — who would disproportionately be lower- and middle-income — would pay more in taxes but also receive more in Social Security benefits. Including employer-sponsored health insurance premiums could close over one-third of Social Security’s solvency gap; including other fringe benefits could close one-tenth.
- Increasing Social Security payroll tax rates. Changes to the tax rate would affect all covered workers and would not change benefits. Increasing rates alone could close the entire solvency gap; even a modest change, such as a gradual increase of 0.3 percentage points each for employees and employers (or less than $3 per week for an average earner), could close about one-fifth of the gap.
Congressional Budget Office. Increase the Payroll Tax Rate for Social Security (2018)
An advantage of this option is that it would provide more revenues to the Social Security program, which, according to CBO’s projections, eventually would not have sufficient income to finance the benefits that are due to beneficiaries under current law. If current law remained in place, Social Security tax revenues, which already are less than spending for the program, would grow more slowly than spending for Social Security. CBO projects that the combined Old-Age and Survivors Insurance and Disability Insurance trust funds would be exhausted in calendar year 2031. Each alternative would extend the insolvency date for the trust funds: The 1 percentage-point increase would delay their exhaustion by about four years, to calendar year 2035, and the 2 percentage-point increase would delay their exhaustion by about nine years, to calendar year 2040.
As things stand now, Social Security’s excess cash is projected to be gone by 2034. While that doesn’t mean bankruptcy, it does suggest that a benefit cut of up to 21% may be needed to sustain payouts through 2092, without the need for any further reductions. With more than three out of five current retirees leaning on Social Security for at least half of their monthly income, a 21% cut would become a major problem.
Congressional Research Service. Social Security: Raising or Eliminating the Taxable Earnings Base (2018)
Raising or eliminating the cap on wages that are subject to taxes could reduce the long-range deficit in the Social Security trust funds. For example, phasing in an increase in the maximum taxable earnings to cover 90% of earnings over the next decade would eliminate roughly 30% of the long-range shortfall in Social Security. If all earnings were subject to the payroll tax, but the current-law base was retained for benefit calculations, the Social Security trust funds would remain solvent for over 60 years. However, having different bases for contributions and benefits would weaken the traditional link between the taxes workers pay into the system and the benefits they receive.
The Social Security system has been the bedrock of retirement security for Americans for over half a century. Over the years, the system has evolved in response to changing conditions. As is well known, program outlays are expected to outpace revenue so that the system faces a shortfall over the next 75 years. Responsible stewardship of the program would necessitate making feasible adjustments to move us towards sustainability.
Long-run balance within the system can be achieved in one or a combination of three ways: by reducing total benefits, by increasing payroll tax revenue currently dedicated to Social Security, or by transferring general revenue to Social Security.
My testimony today will focus on the second of these options – that is, increasing payroll tax revenue. Specifically, I want to suggest that any policy to increase overall revenue through the payroll tax should include an increase in the cap on earnings subject to the tax.
Payroll taxes and growth. Our first task is to look at the relationship between payroll taxes and economic growth. As Figure 1 shows, there is no relationship between payroll taxes and long-term economic growth. Some countries, such as Slovakia, have high payroll taxes and high growth while other countries, such as the United States, have relatively low payroll taxes and low growth.
The OECD provides data on both the employee and employer share of social Security payroll taxes, at four different income levels, and none has any relationship to long-term growth. This is not because payroll taxes are a small source of revenue; they are in fact typically a larger source of revenue than either corporate or personal income taxes.
Heritage Foundation Raising the Social Security Payroll Tax Cap Does Not Fix Social Security (2005)
SSA’s actuarial study showed that that eliminating the payroll tax cap entirely would only delay the start of Social Security’s annual deficits by six years, from 2018 to 2024. Eliminating the wage cap on payroll taxes while paying benefits on only the first $87,900 of earnings would delay the start of annual deficits by an additional year, to 2025.
As well, these policies would delay the onset of massive deficits by only a few years. As Social Security now stands, annual deficits will first reach $100 billion a year (in 2003 dollars) in 2022, according to the 2003 Social Security trustees report. Eliminating the wage cap delays $100-billion deficits until 2029, or only seven years. On the other hand, subjecting all earnings to payroll taxes but only paying benefits on income up to the current wage cap delays the start of those $100-billion deficits until 2031.
Heritage Foundation. Raising the Social Security Payroll Tax Cap: Solving Nothing, Harming Much (2014)
Although often brushed aside as the lesser of our nation’s entitlement problems, the Social Security and Disability Insurance Programs’ $13.4 trillion (and rising) unfunded liability demands substantial reform. Raising the payroll tax cap (from its current level of $117,000) should not be an option. Raising, or even eliminating, the payroll tax cap would not solve Social Security’s financial shortfalls, but would impose economically damaging marginal tax rates on middle-income and upper-income earners. Such onerous taxes would reduce incomes and overall economic growth while generating very little net revenue. Furthermore, Congress would immediately spend any additional payroll tax revenue, leaving no improvement in future budget deficits, giving merely the appearance on paper, of financial improvements in Social Security.
Business Week The Best Way to Reform Social Security (2015)
The most practical, and in my view, the best way to restore system balance would be to simply supplement the payroll tax from other revenue sources, and in particular from the general fund (i.e., income taxes). That would make the program solvent forever. Presto! No more bankruptcy threat.
Which leads to a further idea: Why not supplant the payroll tax altogether, and as soon as possible? The payroll tax is the biggest tax most Americans pay, and regressive. It falls hardest on low-wage workers. Eliminating it would provide meaningful relief to every American wage-earner, with the greatest relief going to those who need the the help the most. Abolishing it would be economically beneficial and politically popular. To avoid increasing the deficit, we could raise or impose other taxes that are less regressive – although, to be honest, I’m not sure we really need to. If anything, America’s less-than-stellar economy could stand a tax cut right now, and what better kind of tax cut than one that reduces burdens on job creation?
Doug Bandow, CATO (2011) Cut Payroll Taxes and End the Social Security Myth (2011)
Nevertheless, cutting the payroll tax can promote smaller, less expensive government. First, the reduction should be made permanent to maximize the economic impact. Potential employers need to be able to make long-term decisions. The best way for government to “create” jobs is to permanently cut the cost of private employers generating jobs.
Second, Congress should make up lost revenues by reducing outlays. The Senate-passed measure raises fees on federal housing subsidies through Fannie Mae, Freddie Mac, and the Federal Housing Administration — which is a step in the right direction. Other, more serious spending reductions should be added.
The payroll tax is a much heavier burden for the middle class than income taxes. According to the Tax Policy Center, 62 percent of all taxpaying households paid more in payroll taxes than income taxes in 2017; and 67 percent of households with incomes below $100,000 in annual income paid more in payroll taxes. The average effective payroll tax rate for households in the middle quintile of the income distribution was 8 percent in 2016, well above the average effective rate of 3.5 percent for income taxes.
In the past, policymakers have been wary of cutting payroll taxes because the revenue is used to pay for Social Security and Medicare Hospital Insurance (HI) benefits, and both programs are projected to run short of funds in the future. The current tax rate for Social Security is 12.4 percent of wages, split evenly between workers and their employers, up to a maximum of $127,200 in 2017. Social Security has an unfunded liability of $12.5 trillion over the next 75 years.
National Review. Why Not Cut the Payroll Tax? (2015)
Some conservatives shy away from taking on the payroll tax because they view it as a lesser evil than the income tax. They argue that because the tax is not progressive (except for the Medicare component, above $250,000 in yearly income), it approximates a “flat” tax on consumption, not savings.
This is a terribly flawed understanding of the tax. The payroll tax is a tax on work, not consumption. Of course, middle-class families generally spend what they earn, and so when they pay taxes, they spend less. But these families can’t avoid the payroll tax by consuming less. Conservatives oppose raising the minimum wage and other mandates that raise the cost of labor and thus limit opportunities for lower-wage workers. They should approach the payroll tax in the same frame of mind because the payroll tax raises the cost of labor far more than any of these other federal mandates. An across-the-board payroll-tax cut would be a powerful pro-work, pro-growth policy.
National Review Cut the Payroll Tax (2017)
The payroll tax is a much heavier burden for the middle class than income taxes. According to the Tax Policy Center, 62 percent of all taxpaying households paid more in payroll taxes than income taxes in 2016; and 67 percent of households with annual incomes below $100,000 paid more in payroll taxes. The average effective payroll-tax rate for households in the middle quintile of the income distribution was 8 percent in 2016, well above the average effective rate of 3.5 percent for income taxes for the same households.