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Dissecting the Payroll Tax

Posted on the 21 November 2011 by ---

Dissecting the Payroll Tax

A graph from Ezra Klein comparing the efficacy of proposed
Social Security fixes

The payroll taxes were created to ensure the solvency of the American social safety net.  Employees and employers each pay 1.45% on all income earned/paid to support Medicare.  However, the system that finances Social Security is more complex.  Currently, there is a tax rate of 4.2% (a temporary stimulus reduction) for income earned by employees, and a 6.2% rate on income paid by employers.  Both are capped at $106,800.  Every dollar paid to an individual after that cap is tax-free.  The result is a tax that is truly regressive; it favors the rich over the poor.  Anyone earning up to $106,800 pays a payroll tax rate of 4.2% in addition to income taxes, sales taxes, and property taxes.  However, someone earning $2 million per year is taxed at a total rate of just .2%!  The more money you earn per year, the lower the percentage of your income you are expected to contribute.  And, the more salary budgets are concentrated in a few people, the less a business contributes.
It is a perverse tax system - one that incentivizes CEO bonuses more than new hires.  And, its regressive nature severely limits the revenues it can collect, endangering the long term existence of Social Security.  We wouln't need to make any adjustments to the way Social Security works for almost a century if we lifted the cap today.  Compare that to the complex schemes of paring down benefits and restructuring the program that are currently being proposed.  Is it worth preserving the status quo, a status quo that hurts job growth and imperils entitlement programs that help millions of Americans?  No.
In fact, we could even afford to lower the payroll tax rate, something conservatives desire, if we simply eliminated the tax cap.  It's a win-win, nonpartisan solution - so why can't Washington get to work and make addressing this a major component of a comprehensive budgetary strategy.

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