Last updated: Oct 18th, 2011

Payroll Tax:

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Payroll tax contributes to unemployment in the US.

A payroll tax is a tax that is associated with the payment of wages to employees. Payroll taxes can be paid by employer, employee, or both. Usually, payroll taxes are set up so that independent contractors pay them equally as wage employees. In the U.S., this is called a "self-employment tax", but this is not a separate tax so much as it is just the form that the payroll tax takes on for self-employed individuals.

As a general principle, I oppose payroll taxes; in fact, I oppose payroll taxes more strongly than any other type of tax that is widely used in the U.S. I see payroll taxes as one of the worst types of tax. Why?

Payroll tax in the U.S.:

Federal payroll tax in the U.S. is one of the worst examples of payroll tax, because not only are there no deductions or exemptions for low-income taxpayers, but there is a "ceiling" on the tax, meaning that only about the first $100K of wage income is taxed. The U.S. federal payroll tax is thus extraordinarily regressive.

Employers vs. Employees Paying Payroll Tax:

Payroll taxes can be paid either by employer or employee. In the U.S., the largest payroll tax, the FICA Tax, is paid by both, in a sense, split between the two.

In political debate and dialogue, people seem to fixate on the distinction between the share of a payroll tax paid by the employer and that paid by the employee. Does it matter who pays this tax?

The question of who pays a payroll tax is really a recordkeeping question. People in the U.S. are often obsessed with the idea (perhaps an artifact of the Union vs. Management mentality associated with big industry) that employees and employers are in a tug-of-war, and that it is better for the employer if the employee pays the tax, and better for the employee if the employer pays the tax. In the long-run, who pays the tax is irrelevant: the cost of employment, relative to the final amount of money in the employee's pocket, is the same. There are some subtle differences in psychology and perception associated with who pays the tax, but the real effect is the same in any case.

While I oppose payroll taxes in general, I think it is better to make them paid, transparently, on each person's tax return. People would be appalled if they realized how much of their salary was taken for payroll taxes, and if they understood the regressive nature of payroll tax. This would quickly produce the political will to eliminate the tax.

Income Tax is Preferable to Payroll Tax:

While I am not a fan of income tax, and would like to see our society move away from or phase out income tax in the long-run, I do think that a straight income tax is highly preferable to a payroll tax. The main reason is that because income tax taxes a broader range of income, a much lower rate is required to raise a comparable rate of revenue. Income tax also provides a barrier to employment and economic activity, but I believe that the general barrier provided by taxing all income at a lower rate is not as destructive as the much more direct and larger barrier produced by a higher tax rate on wage and contract employment.

You can find my comprehensive views on taxes and my long-term proposals for tax reform on my main page on taxes.

Payroll Tax and Social Security:

One objection I have heard to the proposal to eliminate payroll taxes is the idea that payroll taxes fund social security (or medicare, or the other programs funded through payroll tax). People falsely believe that opposing payroll taxes means that a person opposes or wants to shut down social security. This claim is not at all true! Social security is a government program with a certain cost, and the money can be raised through any number of different means.

When social security was designed, it was funded through payroll taxes because viewed it as a sort of pension plan or retirement system. But it is not a retirement system in the sense that money is taken away, it is more of a welfare program that is funded by immediate receipts of money. As such, the money can be raised in any way. I have argued above that payroll taxes are highly damaging to society and to the health of the economy. Regardless of whether or not you want to preserve, dismantle, or change social security, shifting the funding source of social security away from payroll tax and to another tax, such as a straight income tax, would be highly beneficial to the economy.

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