Payroll Taxes Are Taxes

October 20, 2009

Bruce Bartlett remarked in Forbes yesterday (mentioned in an earlier post) that the payroll tax isn’t a tax:

But the biggest problem with cutting the payroll tax is that it isn’t really a tax at all. A tax, by definition, is a compulsory payment for which no specific benefit is received in return. This is not true of Social Security. The vast bulk of workers get back all the money they put into Social Security in the form of a cash benefit in retirement and most get a substantial return. (See this Congressional Budget Office study.) That’s why Franklin D. Roosevelt always insisted that the money withheld from workers’ paychecks for Social Security was not a tax but a “contribution.”

Under that definition, a lot of things are not taxes. Many government services give the taxpayer back something. Public education benefits citizens in some way, but that doesn’t mean the money taken, in say property taxes, to fund schools is not a tax.

With a bit stricter definition, one might say that a compulsory payment is not a tax if benefits received outweigh the cost of payment. But I’d still disagree. Take specifically the payroll tax that funds Social Security. Bartlett says:

In other words, the Social Security tax is more akin to a deduction from one’s paycheck for a 401(k) contribution. Although the worker loses the ability to spend the money immediately, the income is not lost because he knows he will get it all back plus interest when he retires. That is why 401(k) contributions are considered part of one’s compensation rather than a reduction of it.

There are two pertinent differences between a 401(k) plan and Social Security: a 401(k) plan isn’t compulsory, and the average individual returns of a 401(k) plan are greater than those of Social Security. Comparing rates of return for Social Security and the market can be contentious (e.g. the market doesn’t provide things like COLA and some disability benefits). But it seems generally ceded that middle-income earners can expect an individual rate of return of about 2% or less, and high-income earners can expect a return of around 1%. One could buy a bond and get 4%.

If one wants to give a sort of utilitarian definition of taxation they must at least recognize opportunity costs. Just because a government program provides more benefits than costs doesn’t mean one is actually trading with the government. And in discussing the tax wedge of payroll taxes, which depends on the elasticities of demand and supply for labor and business, workers should realize what they are missing.


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