Chances are, if you take a look at your last pay stub, the amount of your check is definitely less than what your salary is. That’s because of payroll taxes. According to the US Department of the Treasury, payroll taxes made up 38.3% of federal tax revenue in fiscal year 2020. To put things in perspective, that equates to $1.31 trillion out of #3.42 trillion.
What are Payroll Taxes?
Simply put, payroll taxes are taxes on the wages of employees. The government uses these taxes to finance social programs like Medicare and Social Security. These payroll taxes are the second largest source of government revenue in the United States.
Have you ever seen FICA and MEDFICA show up on your pay stub? These are the two largest payroll taxes. These taxes combine for a total tax rate of 15.3%. The FICA tax is a 12.4% tax to fund Social Security. MEDFICA makes up the remaining 2.9% tax and is used to finance Medicare. Half of the payroll taxes are directly remitted by employers whereas the other half are taken out of employees’ paychecks. In 2020, payroll taxes only apply to the first $137,700 of income. In 2021, payroll taxes will apply to the first $142,800.
Employer Payroll Tax
Employers also pay a share of some of the payroll taxes. For those of you who started your own business, you likely saw your payroll tax liability double. In fact, the IRS recently announced they would be auditing and cracking down on businesses who don’t pay enough in payroll taxes.
Employers are required to withhold state and federal income taxes from their employee’s earnings, including Social Security and Medicare taxes. Social Security and Medicare taxes are also known as FICA taxes. Federal payroll taxes are consistent nationwide whereas state payroll taxes vary across state lines. The share of FICA taxes that the employer is responsible for paying are considered a business expense, not a liability. This means it can be written off at tax time.
Who Really Pays Payroll Taxes?
On the surface, it seems like payroll taxes are split 50/50 between employees and employers. However, it turns out that employees effectively pay almost the entire payroll tax.
This is because the party that is required to pay a tax is often different than the person who bears the tax burden. Contrary to popular belief, tax incidence is not determined by law, but by the laws of supply and demand.
It turns out that workers’ willingness to work (Labor Supply) is much less sensitive to taxes than employers’ willingness to hire (Labor Demand). Workers who need a job are not as responsive to changes in wages whereas businesses are able to adopt new technology and shift production to different locations.
The graph above illustrates how the tax burden on employees is much higher than employers. The labor supply line is steeper because workers are less sensitive to changes in wages than employers. Rather than workers and employers each paying 7.65% in payroll taxes, employers send their portion of the tax to the government while decreasing workers’ wages by almost 7.65%. This means there is barely a tax burden on employers, with most of the burden falling on the employees in the form of lower wages.
Payroll taxes reduce your take home pay significantly. On top of that, the governments position on employer side payroll taxes is misleading. They claim that employers pay half when in reality most of the tax burden is passed onto the workers.
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