Social Security, financed by payroll taxes, is the most extensive federal program and accounts for almost one-quarter of federal spending. A study concluded that two-thirds of the elderly are rescued from poverty with Social Security assistance. However, this program faces a long-term funding shortfall, and its reserves are depleting pretty fast. Presently, if policymakers don’t act, the program’s beneficiaries will not be getting their full benefits.
One potential solution is to increase the payroll tax rate for Social Security. Payroll tax is the percentage withheld by an employer from an employee’s pay and remitted to the federal government. These taxes support Social Security and Medicare funds and comprise 36 percent of total federal revenue.
Although increasing payroll taxes will boost funds to the social insurance programs, opponents of this idea argue that the heavy payroll taxes will burden middle-class Americans, and workers’ take-home will reduce as a large amount of their salary will go into the taxes. Read on more to know about payroll taxes, its funded insurance programs, and the implications of increasing payroll taxes.
What Are Payroll Taxes?
Payroll taxes are deducted from the employee and employer on wages up to a certain level. These taxes cover Social Security and Medicare contributions, which fall under the Federal Insurance Contributions Act (FICA) tax. In addition, payroll taxes also fund smaller programs like the Unemployment Insurance program and federal government retirees and railroad workers.
Social Security Payroll Tax
The Social Security backed by FICA’s funds supports the Old-Age and Survivors Insurance and Disability Insurance programs. These programs provide income to retirees, disabled people, and their families every month. In 2019, payroll taxes, the primary source, poured 88 percent of funds (around $914 billion in revenue) into Social Security programs.
Both employers and employees have to pay 7.65 percent of payroll in FICA taxes— the portion allocated to Social Security is 6.2 percent. It is levied only when an annual income reaches a certain determined level, while the remaining 1.45 is dedicated to Medicare.
What about self-employed individuals? These are taxed through Self-Employment Contributions Act (SECA) taxes, similar to the FICA. However, if you are a freelancer, artist, or musician, you must pay for employee and employer tax portions.
What is the Social Security Tax Cap?
The Social Security payroll tax is applicable only on a certain amount of a worker’s annual earnings. This limit is the taxable maximum or Social Security tax cap. For 2022, that maximum is set at $147,000, increasing $4,200 from 2021. The Social Security Payroll tax is considered a regressive tax because as the earning cross the cap, the total taxable amount is decreased.
Unlike income taxes, where higher-income taxpayers pay a large share of their income in taxes, low and middle-class individuals pay a more significant proportion of their income in payroll taxes than do higher-income taxpayers.
Medical Payroll Tax
Both employers and employees contribute 1.45 of their earnings to fund Medicare, collected on all income. From 2013, an additional 0.9 percent in Medicare is paid by employees earning between $125,000 and $250,000. The policymakers eliminated the Medicare payroll tax cap in 1994.
The Hospital Insurance (HI) program pays for hospital stays and home healthcare through payroll taxes, like hospice care. As of 2019, HI tax revenues were recorded at 1.3 percent of gross domestic product (GDP).
Additional Federal Payroll Taxes
In addition to the taxes discussed above, other federal payroll taxes include:
- Federal Unemployment Tax Act (FUTA) taxes: Only employers pay these taxes to support funding for unemployment insurance programs. The unemployment insurance rate may vary depending on the industry, state, and federal fees.
- Railroad Retirement Act taxes are subjected to only railroad employees and employers to fund their retirement programs.
- Other payroll taxes mainly comprise taxes paid by federal employees to fund their retirement programs.
The Effect of Increasing Payroll Tax Rates On Social Security
Raising the payroll taxes for Social Security was among the current US President Joe Biden’s plans and remarking no one, not even President Trump, argued against it. That explains one thing: there is an understanding among voters now that the Social Security system is in shambles financially. Social Security faced solvency issues before, but with the tax reforms, these were resolved: the most prominent were the 1983 amendments to the Social Security Act.
So, what did President Biden propose? Biden’s suggested reimposing the tax on anyone earning over $400,000 in addition to the current maximum taxable amount, giving birth to a hole (donut-hole) between $142,800 to $400,000 in earnings.
Surprisingly, Biden won the election for acknowledging the issue and building consensus for a solution. The changes in the payroll tax rate would affect all the workers, especially low-income individuals who’d salary will reduce, and it would not change the benefits. However, it could narrow down the Social Security‘s solvency gap with even a slight change.
It’s about time that policymakers take serious measures to increase the social security payroll taxes. Increasing the revenues will help to restore the solvency of the program.
Changes in Payroll Tax Cap for the Social Security Program
The proposals in the table are to increase, eliminate, or adjust the payroll tax cap. The increase in the social security payroll tax cap has been evident over many years. The proponents of increasing or eliminating the limit on the total earnings suggest that it would make the tax more progressive and strengthen the Social Security trust funds.
According to the Congressional Budget Office, including the earnings above 250,00 in the payroll taxes would generate around $1 trillion in revenues over ten years. Opponents argue that increasing or removing the taxable limit will affect the benefits that individuals get from Social Security. Because the Social Security program is progressive, low-income taxpayers receive a more significant share of government payments that aren’t subjected to the tax.
Social assistance programs funded by payroll taxes face a financial shortage. People have shown their willingness to back Social Security through more tax contributions. Opting for various solutions, as discussed above, can close the Social Security’s financial gap.