“In Proportion To Their Respective Abilities” – Making the Payroll Tax Progressive

In Budget Politics, Economics, New Deal, Political Ideology, Politics of Policy, Social Democracy, Taxes on July 12, 2009 at 11:38 am

The expense of defending the society, and that of supporting the dignity of the chief magistrate, are both laid out for the general benefit of the whole society. It is reasonable, therefore, that they should be defrayed by the general contribution of the whole society, all the different members contributing, as nearly as possible, in proportion to their respective abilities.

(Adam Smith, Wealth of Nations, Book 5, Chapter 1, Part 4)

One of the peculiar glories of American public policy is that, of the nations of the world, our tax system is generally progressive (or at least used to be). In comparison to other countries, we rely more on the income tax, less on VAT taxes, and our corporate tax rate is actually (on paper) more progressive than most countries.

The legacy of more than a century of political combat, the progressive income tax, capital gains tax, and estate tax are proud legacies of the Democratic Party, from the earliest days when then-Congressman William Jennings Bryan and other Populist Democrats were pushing the income tax through Congress (it would be nullified by the Supreme Court), to the passage of the 16th Amendment in 1913 as part of Wilson’s New Freedom, to FDR’s soak-the-rich tax program, to the WWII era when American taxation reached its most progressive level. It is hard to comprehend, as someone who grew of age in a political era in which tax cuts were the only policy option, that once, the top income tax bracket was once 90%.

The Payroll Tax:

And yet, the great glaring omission of American taxation is the payroll tax, which accounts for 36% of Federal revenue. The FICA tax, as everyone knows, works out to 15.3% of wages up to $102,000 a year (12.4% for Social Security, and 2.9% for Medicare, split between employer and employee). Because the payroll tax is a flat rate (it doesn’t increase or “progress” as wages go up) and because of the cap on wages taxed (for Social Security),  the payroll tax is deeply regressive – poor, working class, middle class, and even affluent Americans pay the full 12,4% on their sub-$102k salary (either individually or through their employer), whereas someone making $200k a year effectively pays only 6.5%, someone making $500k a year effectively pays only 2.6%, and someone making a million dollars a year pays a paltry 1.3%.

Our Frayed Safety Net:

At the same time that the payroll tax’s regressive nature (and the declining progressivity of the income, capital gains, and estate taxes) places a substantial stumbling block in the path of efforts to reduce economic inequality in America, it’s also true that the programs that the payroll tax is supposed to fund need work. As I pointed out previously, there is much work that needs to be done in improving the quality of the American safety net.

At a time when nearly one in ten American workers are unemployed, only half of them qualify for Unemployment Insurance, to the extent that the program no longer adequately functions either as a safety net or an “automatic stabilizer.” While I will vigorously dispute with anyone who claims that Social Security is in a crisis, I do believe that the program no longer provides an adequate pension for people to retire on (especially as the supplementary employer-based pensions are rapidly disappearing and 401ks and similar programs have proved themselves far too vulnerable to stock market swings), and that efforts should be taken to improve the quality and quantity of income and other supports as the Boomer generation retires.

Making the Payroll Tax Progressive:

So in order to make the payroll tax a truly progressive instrument, only two steps are necessary.

First, remove the Social Security Wage Base cap. Citizens for Tax Justice has estimated that this will raise $125 billion a year, and put Social Security on a very good financial footing. In and of itself, it doesn’t change the fact that the payroll tax would still be a flat tax, but it would be a good step in the right direction, in that it would at least stop giving people in the top 10% a public present.

Second, give the vast majority of Americans a payroll tax cut, and tax the rich according to their ability to pay.

$0-20k a year, reduce to 2% individual, 2% employer (4% total, plus 2.9% for Medicare).

$20-30k a year, reduce to 3% individual, 3% employer (6% total, plus)

$30-50k a year, reduce to 4% individual, 4% employer (8% total, plus)

$50-110k a year, reduce to 5% individual, 5% employer (10% total, plus)

$110-150k a year, stays the same

$150-200k a year, increase to 7%/7% (14% total)

$200-300k a year, increase to 8%/8% (16% total)

$300-500k a year, increase to 9%/9% (18% total)

$500k-$1 million + a year, increase to 10%/10% (20% total)

Why Do This?

There are several advantages to making the payroll tax truly progressive.

  • It would definitively put Social Security and Medicare on a solid financial foundation, covering 93% of the funding gap for the next 75 years (according to the SSA).
  • By dramatically increasing the revenues available, it would allow for major improvements to Old Age Insurance (raising benefits to a pension that actually could be retired on), Medicare (improving the quality and variety of services), and Unemployment Insurance (expanding eligibility, increasing the replacement rate of the benefit, creating new services).
  • It would dramatically increase the progressivity of the American tax system, reducing the economic burden on poor, working class, and even middle class Americans, while the automatic withholding on higher incomes would make it more difficult for the rich to avoid paying taxes through the abuse of tax shelters.
  • As progressive economists like L. Randall Wray have argued, a payroll tax holiday in this economic crisis would create an incentive to create jobs. I would argue that a progressive payroll tax would create a larger, systemic incentive to expand the number of jobs that pay under $150,000 a year (i.e, living wage and middle class jobs) while creating a disincentive to hand out lavish salaries to executives, creating a labor market that more resembles a bell curve than a barbell.

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  2. […] this is to fix the unemployment insurance (UI). Our current UI system is fundamentally broken. As I wrote on the 12th, “at a time when nearly one in ten American workers are unemployed, only half of […]

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  4. […] Insurance and Payroll Taxes – reforming the payroll tax helps Job Insurance. One of the major drawbacks to the current […]

  5. […] Taxes – In “In Proportion to Their Abilities,” I’ve already discussed how making the payroll tax a progressive tax would raise well […]

  6. […] this is to fix the unemployment insurance (UI). Our current UI system is fundamentally broken. As I wrote on the 12th, “at a time when nearly one in ten American workers are unemployed, only half of […]

  7. […] investment. What I find surprising is that more people haven’t hit on the idea of permanently progressivizing the payroll tax as an option. Progressivization provides solutions for many of the drawbacks of a payroll tax […]

  8. […] Simpson plan. It actually recognizes the importance of economic growth by establishing a one-year payroll tax holiday and backloading the cuts to further out, so that the economy has more time to recover before they […]

  9. […] a symbolic link between contribution and eligibility for Social Security, there is no reason why making the payroll tax a progressive tax should not be at the heart of progressive tax policy. At one stroke, we would increase purchasing […]

  10. […] can be designed to be progressive, and even nominal for the poorest. Virtually no system of social insurance is self-supporting on […]

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  12. […] effective income of middle class families and reducing the need for dangerous levels of debt. Progressivizing the payroll tax  could increase middle-class take-home incomes by 5-7% and create a permanent economic incentive […]

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