Integrating the tax burdens of the federal income and payroll taxes on labor income: 3. PAYROLL TAXES IN CONTEXT OVER TIME

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

III. PAYROLL TAXES IN CONTEXT OVER TIME

As of 1999, nearly two-thirds of families pay more in payroll taxes than they do in income taxes, while fewer than one-quarter of families pay more in income taxes than they do in payroll taxes. (58) By comparison, in 1979, only forty-four percent of families paid more in payroll taxes than income taxes. (59) Moreover, the families that pay more in payroll taxes than in income taxes are overwhelmingly low- and middle-income families. Mitrusi and Poterba showed that an overwhelming majority of families with adjusted gross incomes of $100,000 or less in 1999 paid more in payroll taxes than in income taxes; however, very few families with adjusted gross incomes of more than $100,000 paid more in payroll taxes than income taxes. Mean income taxes do not reach approximate parity with mean payroll taxes until one reaches $75,000 to $100,000 of adjusted gross income (AGI), increased by certain items of untaxed income (adjusted AGI). (60) "At income levels below $50,000, more than three-quarters of families have payr oll tax bills that exceed their income taxes. At adjusted AGI levels above $200,000, income taxes exceed payroll taxes for virtually all families." (61)

These conclusions are only marginally less dramatic if solely the employee share of payroll taxes is taken into account. As noted earlier, most economists assume that the incidence of the employer share of Social Security taxes falls on the employee. Nevertheless, the last column in the table above breaks out the percentage of families for whom the employee share of payroll taxes exceeds the personal income tax.

Not surprisingly, excluding half of each family's payroll tax burden substantially reduces the likelihood that payroll taxes exceed personal income taxes. However, employee payroll taxes still exceed personal income taxes for 35 percent of all families, and for more than 40 percent of all families that pay taxes. Families in the lowest income ranges, with adjusted annual AGI of less than $20,000, have a greater than 50-percent chance of paying more in employee payroll taxes than in personal income taxes. Conditional on paying any taxes at all, these families' chances of paying more in employee payroll taxes than in personal income taxes are greater than four in five. (63)

Mitrusi and Poterba also illustrated the increasing burden of payroll taxes relative to income taxes between 1979 and 1999, and this increase in burden was most dramatic for middle-income taxpayers with adjusted AGIs of between $30,000 and $100,000. For example, the table below shows that, in 1979, 45.8% of families with adjusted AGIs of between $30,000 and $40,000 pald more in payroll taxes than in income taxes, but that percentage nearly doubled to 85.7% by 1999. Even more dramatic was the increase from 4.6% to 55% for families with adjusted AGIs of between $75,000 and $100,000. Moreover, the increases are even more pronounced if the sample is limited to only families that actually paid taxes. The table shows that for families with 1999 adjusted AGIs between $10,000 and $20,000, for example, 71.2% of all families but 87.5% percent of families with positive tax liabilities had 1999 payroll taxes in excess of personal income taxes. Mitrusi and Poterba also showed that these effects were particularly dramatic for two-earner married couples, where the cap on taxable earnings can result in a greater aggregate payroll tax liability for a given level of family earnings. (64)

What to make of these observations? If the allocation of total revenue receipts between income and payroll taxes had remained relatively constant in this period, these numbers actually might be quite positive. Under such an assumption, they could possible demonstrate that the income tax burdens of low- and middle-income families have been substantially shifted to the upper classes during this period, which would mean that relatively constant payroll tax payments could then exceed income tax payments for more members of this class. It is true that the income tax reaches fewer low-income families today than in the past, due mainly to the enactment and expansion of the earned income tax credit. (66) When the relative contributions of payroll taxes and income taxes to total national revenue are considered, however, it becomes apparent that these numbers are due in large part to substantial increases in the payroll tax rates as well as substantial increases in the Social Security wage base in the last two decades. Payroll taxes have funded an increasingly larger share of total federal tax revenue since the early 1980s. Even though the taxes are imposed at a flat rate, the wage ceiling feature of the tax base means that it is both regressive (with the average tax rate falling as wages increase) and concentrated in the poor and middle classes. The significant increases in the payroll tax rates and the wage base since the early 1980s explain why these taxes have become an increasingly larger share of the total tax burden for those families with less than $100,000 of income. "Until 1963, federal receipts from the individual income tax were more than twice as great as federal payroll tax revenues. In 1995, payroll tax receipts were approximately equal to income tax receipts." (67) This observation is confirmed by data showing that, when income and payroll taxes are combined, most upper-income taxpayers realized an aggregate tax decrease between 1979 and 1999, while low-income taxpayers generally experienced a tax increase.

If we restrict the analysis to families that paid either payroll or income taxes..., the data show that 70.2 percent of families faced lower income taxes in 1999, but that only 37.5 percent faced lower income and payroll taxes. At low family income levels, most families experienced a tax increase between 1979 and 1999. We need to focus on families in income strata above $50,000 before the probability of paying lower combined taxes in 1999 than in 1979 rises above 50 percent. [These results] provide a stark demonstration of the importance of combining income and payroll taxes when considering recent changes in tax burdens. (68)

These numbers will become even more pungent when phase-in of the 2001 Act is complete. (69)

I have been unable to find data comparable to that of Mitrusi and Poterba for the early years of the payroll taxes. Nevertheless, it is fair to say that the increasing tax burden on labor income of the lower and middle classes (from the combination of payroll and income taxes on labor income) evident from 1979 to 1999 is a relatively new phenomenon. Consider two other emblematic tax years: 1939 and 1960. (70) In 1939, the payroll tax was established but the income tax had not yet become a mass tax. In 1960, the income tax had itself become a mass tax, imposed on the lower classes in addition to payroll taxes. Moreover, that year is only seventeen years before the beginning of the twenty-year period examined by Mitrusi and Poterba.

In 1939 (and, indeed, through 1949), the combined employer and employee Social Security tax was two percent (one percent each), which was imposed on wages up to $3,000. (71) Because of the generous personal exemptions under the income tax--$2,500 for married couples and $1,000 for single taxpayers, along with $400 for each dependent, (72) at a time when few households earned as much each year--the two-percent payroll tax was the only tax paid by the vast majority of lower- and middle-class workers. Even during the "high tax" years of World War I, "at most 13 percent of the labor force [paid] income taxes." (73) When tax collections decreased in the 1920s after the end of the war, Yale economist T.S. Adams wrote that the income tax "touches directly perhaps only 5 or 6 percent of the population." (74) By 1939, only about five percent of the population paid income taxes. (75)

By 1960, the income tax was entrenched as a mass tax, with approximately seventy-three percent of the population covered by taxable returns. (76) The personal exemptions had been reduced to $600 for a single individual and $1,200 for a married couple in 1948, and they remained unchanged by 1960 in spite of the reduced economic value of those amounts with inflation. But the income tax rates applicable to the lower classes were still relatively low, so that those with adjusted gross incomes of less than $5,000--when the average annual salary in the early 1960s was $4,700 (77)--contributed just 8.8% of aggregate individual income tax revenue in 1965. (78) Moreover, while the payroll tax wage base increased to $4,800--almost precisely the average annual salary--and the combined Social Security tax rate increased to six percent (three percent each for the employer and employee), (79) the payroll tax, which did not yet include the Medicare tax, was still low compared to modem standards. Therefore, it is fair to say that the combined tax rate on the labor income of the poor and middle classes was still low by comparison to today. The bulk of federal revenue was collected from the upper classes, and the balance between taxation of labor income and taxation of capital income was not nearly as skewed toward labor income as today.

This brief review suggests that one means by which we could decrease the tax burden on the labor income of the lower and middle classes to restore a balance closer to historical standards (without explicit integration of the two taxes) would be to repeal the wage ceiling under the Social Security tax. The Social Security tax would then apply to an unlimited amount of wages, like the Medicare tax. Elimination of the wage ceiling would allow a slashing of the Social Security tax marginal rate. In other words, eliminating the wage ceiling could pay for substantial rate cuts (perhaps closer to the three-percent rates of 1960) in a revenue-neutral fashion. Such lower marginal rates should also reduce any behavioral distortions, and thus sacrifices in economic efficiency, that accompany the relatively high Social Security tax rates of today. (80)