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Payroll Taxes Hit Most Americans Harder than Income Taxes

2 min readBy: Gerald Prante

In the rush to file their federal income 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. forms for tax year 2006, Americans may not look closely enough at their W-2s and may not realize the true economic incidence of payroll taxes; they may not realize that they probably paid more in federal payroll taxes than in federal income taxes last year. Most economists agree that virtually all of the 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. burden is borne by workers, even that portion that is legally paid by the employer. And so when we count that as a tax on the worker, we begin to realize that this 15.3 percent tax rate can be higher than the income tax rate that these individuals are paying; most of them lie below the Social Security cap ($97,500) and fall in the 10 and 15 percent taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. brackets (with possibly some income being taxed at the 25 percent rate). Only for high-income earners or those who earn most of their income in non-wage form will their income tax burden exceed their payroll tax burden.

The Tax Foundation recently released a Fiscal Fact looking at how different types of taxes weigh differently on different income groups. Among the study’s highlights (from 2004 data):

For households in the bottom 20 percent of the income scale, the average payroll tax burden per household for tax year 2004 was $917, while the average federal income tax burden per household (excluding refundable portion of EITC) was $171.

For the middle income group, the average payroll taxes paid per household was nearly double the average federal income tax.

For the bottom 40 percent of households, property taxes, payroll taxes, and state/local general sales taxes was each a larger hit on households than the federal individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. .

The federal individual income tax is much more progressive than state/local income taxes. As a quick illustration, for every dollar in federal individual income taxes paid by the middle income group, the top quintile paid $7.86 in federal individual income taxes. At the state/local individual income tax level, that number was $5.36.

Individual income taxes at both the federal and state/local level drive the bulk of the progressivity in the entire tax system. As a quick illustration, for every dollar of total taxes paid by the middle income group in 2004 at all levels of government, the top quintile paid $3.87 in taxes. However, excluding all individual income taxes, that number drops to around $2.82.

The bottom quintile pays more in taxes on tobacco and alcohol (at all levels) than in federal individual income taxes, even after excluding the refundable portion of EITC.

For more on how different types of households are hit harder by different types of taxes, check out the full working paper on which these numbers are based.