A tricky tax policy

Payroll taxes may cost us a larger chunk of our paychecks than we think.

by Derek Olson

One of the many funny moments I remember from my favorite TV show “Friends” is when Rachel receives her first-ever paycheck. Her immediate reaction is to exclaim, “Who is FICA, and why’s he getting all my money?” FICA stands for Federal Insurance Contributions Act. As many young people learn from their first job, it’s a payroll tax that the government takes directly from a paycheck and uses to fund Social Security and Medicare. The truth is that FICA actually takes even more money from a paycheck than many realize.

On your paycheck, you will see FICA taxes of 7.65 percent (taken from income up to $117,000). Of that 7.65 percent, 81 percent goes toward Social Security and 19 percent toward Medicare. Additionally, the government requires employers to contribute the same amount, which makes the total payroll tax 15.3 percent.

Here’s the juicy kicker that most people don’t know: The idea that employers pay half of the payroll tax is an accounting fiction. In reality, economics teaches that employees bear the burden of the payroll tax. Employees truly pay closer to the full 15.3 percent of their income to FICA.

If an employer pays $10 per hour to hire an employee, it makes no difference to that employer whether they pay $10 to the employee and $0 to the government, $0 to the employee and $10 to the government or any combination thereof. The only thing the employer cares about is the total cost of hiring someone, which includes both wages and payroll taxes. By this principle, the employer only pays its share of FICA taxes on paper. Employers compensate for the tax with what would otherwise be a larger paycheck.

This is important for several reasons. Employers dupe employees regarding how much they actually pay in taxes because 7.65 percent appears meager compared to 15.3 percent. Whether the designers of the payroll tax were intentionally cunning or simply ignorant, the payroll tax is deceptively high. This is particularly important for young people to understand. With the long-term sustainability of Social Security questionable at best, reform will be necessary. At the very least, we shouldn’t have such trickery in our tax policy.