Integrating the tax burdens of the federal income and payroll taxes on labor income: 2. INCOME AND PAYROLL TAXES ON LABOR INCOME

By Geier, Deborah A.
Publication: Virginia Tax Review
Date: Saturday, June 22 2002

자료: Integrating the tax burdens of the federal income and payroll taxes on labor income

II. INCOME AND PAYROLL TAXES ON LABOR INCOME

American taxpayers are generally subject to three federal taxes imposed on wages and self-employment income, as opposed to capital income. The earliest of these taxes was the so-called income tax, which is today actually a hybrid income/consumption tax, first enacted in 1913 after adoption of the Sixteenth Amendment to the Constitution. (35) Though commentators bemoan the difficulties of fully taxing income from capital under our current income tax, (36) the tax is (at least nominally) imposed on income both from labor and from capital. (37) Indeed, one of the fundamental impetuses underlying the move toward income taxation was a desire to tax income from the capital of the wealthy. This income essentially escaped taxation under the various consumption taxes, such as imposts and tariffs, which funded the operations of the federal government prior to 1913. (38) The debates surrounding the concept of income taxation clearly evidenced the policymakers' intention to achieve greater fairness in the allocation of t he tax burden. They show a common understanding that prior modes of taxation were consumption taxes that were regressive in nature and that an income tax would more fairly apportion the tax burden to those with greater wealth. (39)

In view of this early desire to use income taxation to effectuate a more progressive allocation of the tax burden, the income tax, though of earliest application, did not apply to a great many taxpayers (40) until the advent of World War II, when it was forever "transformed from class tax to mass tax." (41) The early desire to use the tax to reach chiefly the capital income of the wealthy was attenuated by the need for larger revenues to fund the war effort and post-war government policies, though the rate structure of the income tax remained highly progressive in this era. While middle-class taxpayers were subject to the tax on a massive scale for the first time, the marginal rates applicable to these taxpayers were significantly lower than the ninety-percent plus rates applicable to the highest income earners.

The two so-called payroll taxes discussed here are imposed on labor income only, and they were introduced at different points in time. The first was the Social Security tax, enacted in 1935 (42) and substantially broadened in 1939 (43) (and many times thereafter) as part of President Roosevelt's New Deal. For employees, the tax base for this tax is "wages," and an equivalent self-employment tax is imposed on self-employed individuals. For 2002, the Social Security tax is imposed on the first $84,900 of wages or self-employment income, (44) with no personal exemptions, deductions, or zero-bracket amount of any sort, unlike in the income tax. The ceiling increases each year according to the increase in average wages in the U.S. economy. Wages or self-employment income earned above the ceiling amount are free from these taxes. Therefore, Bill Gates pays the same in Social Security tax as a college professor earning $84,900 per year in wages. The employee must pay tax at a rate of 6.2% on this tax base, (45) while the employer pays an additional 6.2% (46) (summing up to 12.4%), though economists generally agree that the incidence of the employer portion of the tax falls mostly on the employee in the long run through wages that are depressed by an equivalent amount. (47) The self-employed pay the entire 12.4% directly. (48)

The Medicare tax, also imposed on a tax base of wages (or self-employment income), was enacted in 1966. (49) The Medicare tax, unlike the Social Security tax, is now imposed on all wages and self-employment income, without limit, and is imposed at a combined employer and employee rate of 2.9% (1.45% on each). (50) Once again, the self-employed pay the entire 2.9% directly. (51) Thus, wages and self-employment income up to $84,900 (as of 2002) are taxed at a total combined flat rate of 15.3%, with no exemptions or deductions, while wages and self-employment income above that ceiling continue to be taxed at a flat rate of 2.9%.

None of the payroll and self-employment taxes are creditable against the tax due under the income tax, and none of them are formally deductible by employees under the income tax. Because the incidence of the employer portion of these payroll taxes likely falls on the wage-earner, however, the employee gets an effective deduction for these taxes, as though payment of the taxes were included in the employee's gross income as additional wages, and then the employer portion of the tax were deducted by the employee. Thus, it is more accurate to say that, in substance, the employee is effectively allowed to deduct one-half of the 15.3% aggregate payroll tax economically borne by him but not the other half. To achieve parity, the self-employed are expressly allowed to deduct one-half of their self-employment taxes under section 164 of the Internal Revenue Code (Code). (52)

Although money is fungible, and thus tracing government outlays from any particular tax stream is conceptually problematic, the Social Security and Medicare taxes are commonly perceived to be the source of funds for several kinds of government benefits. (53) The biggest and most well-known is the old-age and survivors benefit, payable to those in retirement who have worked at least forty quarters (three-month periods) in the paid labor force (unless exempted from the system (54)), as well as their surviving spouses. Joint federal-state programs dealing with disability payments are also funded by these payroll taxes.

Under the complex rules in section 86, a certain portion of old-age and survivors benefits is taxed under the income tax when received. Daniel Shaviro explains the rules as follows:

Under a maddeningly complex set of rules, Social Security benefits are excluded for income tax purposes by individuals with modified adjusted gross incomes below $25,000 ($32,000 for married couples). Above that point, the benefits are 50 percent includable, and the resulting income tax revenues officially attributed to the Social Security Trust Fund. The inclusion percentage rises to 85 percent for individuals with modified adjusted gross incomes above $34,000 ($44,000 for married couples), with the extra revenues from the increase in inclusion percentage being officially attributed to Medicare. (55)

In 1999, about 45.7 million people received old-age and survivors benefits, while 9.6 million individual income tax returns reported taxable benefits, a record high. (56) Disability payments are treated the same as old-age and survivors benefits. (57) The value of free medical care received in kind pursuant to the Medicare program is not taxed under the income tax.