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The Mischiefs of Tax Withholding and Separate Income and Payroll Taxes

2 min readBy: Joseph Bishop-Henchman

Charles Murray has an op-ed in the Wall Street Journal criticizing taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. and the separation of payroll taxes from income taxes:

Fold payroll taxes into the personal tax code, adjusting the rules so that everyone still pays the same total, but the tax bill shows up on the 1040. Doing so will tell everyone the truth: Their payroll taxes are being used to pay whatever bills the federal government brings upon itself, among which are the costs of Social Security and Medicare.

The finishing touch is to make sure that people understand how much they are paying, which is presently obscured by withholding at the workplace. End withholding, and require everybody to do what millions of Americans already do: write checks for estimated taxes four times a year.

Both of those simple changes scare politicians. Payroll taxes are politically useful because low-income and middle-income taxpayers don’t complain about what they believe are contributions to their retirement and they think, wrongly, that they aren’t paying much for anything else. Tax withholding has a wonderfully anesthetizing effect on people whose only income is a paycheck, leaving many of them actually feeling grateful for their tax refundA tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. Overpaying taxes can be viewed as an interest-free loan to the government. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s. check every year, not noticing how much the government has taken from them.

There’s definitely something to it. Most people hate property taxes more than any other tax precisely because it is so visible. People get angry, they scrutinize how property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. money is spent, and that’s a good thing. We could use more scrutiny of expenses with income and payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. money.

Milton Friedman, of all people, invented payroll tax withholding during World War II as income tax rates soared. He later regretted what he had wrought.

The income-payroll distinction goes back to idea that Social Security and (later) Medicare are somewhat based on the benefit principle. People pay in, they later get benefits. This is why Social Security taxes aren’t collected past a certain income level: someone paying in above that cap would never get that money back unless they lived virtually forever. But it does make that “FICA withholding” seem no different from any of the other myriad withholdings on the pay stub. And it’s probably deceptive to pretend that Social Security isn’t a government program intertwined with the rest of the federal budget.