Payroll tax

The payroll tax has been in the news quite a bit recently, but what is it?

According to Investopedia:

A payroll tax is a tax withheld from an employee's salary by an employer who remits it to the government on their behalf. The tax is based on wages, salaries, and tips paid to employees. Payroll taxes are deducted directly from the employee's earnings and paid directly to the Internal Revenue Service (IRS) by the employer. In the United States, payroll taxes are divided into three main categories: Federal income, Medicare, and Social Security. The government also collects money for federal unemployment programs.

For our discussion we'll be talking about Social Security since that's what the payroll tax cut is about. I talked about Social Security last week.

More from Investopedia:

Federal payroll taxes cover Social Security and Medicare contributions, which constitute the Federal Insurance Contributions Act (FICA) tax. An employee pays 7.65%. This rate is divided between a 6.2% deduction for Social Security on a maximum salary of $137,700, while the other 1.45% goes to Medicare. There is no salary limit on Medicare, but anyone who earns more than $200,000—or $250,000 for married couples filing jointly—pays another 0.9% for Medicare.

The employer pays a matching amount into both programs

This article from Kiplinger talks about the payroll tax cut:

Since negotiations for another stimulus bill are going nowhere, President Trump issued a series of executive orders to help financially distressed Americans. One of the executive orders (actually an executive "memorandum") suspends the collection of Social Security payroll taxes from September 1 until the end of the year for workers making less than $4,000 for any bi-weekly pay period (that's $2,000 per week, or $104,000 per year). 

There are plenty of lawmakers on both sides of the aisle who don't favor a payroll tax cut (or deferral). It's not enough and doesn't benefit people who need help the most, they say. It's also possible that employers won't comply with the executive order and that the deferred taxes will still have to be paid later.

Why wouldn't employers comply with the order?

The executive order only defers Social Security payroll taxes – it doesn't eliminate them. It would take Congressional action to actually wipe out the tax debt. As a result, some employers might continue to withhold Social Security payroll taxes from their workers' paychecks to avoid a large bill when the taxes eventually become due (a bill that they could have to pay themselves or by withholding a large amount from paychecks later). Mnuchin has also acknowledged that the president's order doesn't force businesses to stop withholding the tax. Many employers are expected to wait until the IRS issues guidance on the deferment before deciding whether or not to halt Social Security tax withholding.

The president's order also directs the Secretary of the Treasury to "explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred," and Trump said he would "terminate" the suspended taxes if he's re-elected. But at this point there's no telling if the eventual payment of the deferred taxes will ultimately be avoided.

So, how much will this tax deferral save you? Again, from Kiplinger:

Under the president's executive order, your share of Social Security taxes (6.2%) won't be taken out of your paycheck if your pre-tax bi-weekly salary is $4,000 or less. So, for example, someone making $10 per hour and working 40 hours per week will get about $25 more per week, or around $100 per month. From September through December, that will add up to about $446. A full-time worker making $15 per hour would get approximately $37 more per week, $149 more per month, and $670 by the end of the year. For someone making $25 per hour, the savings will be about $62 per week, $248 per month, and $1,116 through December.

Since the executive order doesn't apply to bi-weekly wages above $4,000, the maximum tax deferral is $124 per week, which would add up to $2,232 from September 1 to December 31. (That's based on 40 hours per week at $50 per hour.) The $4,000 cap also means that the $137,700 wage base limit for Social Security taxes doesn't come into play.

Since the goal is to quickly get more money into the economy, critics claim that the infusion of cash into the economy would come too slowly from a payroll tax holiday. Instead, many lawmakers and experts would prefer another round of stimulus checks to get more money, more quickly into consumers' hands.

It's not a huge amount of money, but if you're working it'll help a little. But what about if you're not working?

Obviously, you have to get a paycheck to benefit from a payroll tax cut. So, if you're unemployed, retired, a stay-at-home parent, or don't have a job for some other reason, then the payroll tax holiday won't help you. This is one of the chief concerns among Democrats (and some Republicans), who believe the people who need support the most aren't helped by a payroll tax cut. Many of them would rather see expanded unemployment benefits and assistance to state and local governments instead.

But what does the payroll cut mean for Social Security?

There's also concern about the impact on the Social Security trust fund, which is already dealing with financial issues. Since payroll taxes fund Social Security, many people are worried about the long-term effects of diverting money away from this social safety net for seniors.

Treasury Secretary Steven Mnuchin, however, says that Social Security funding won't drop. Money will be transferred from the federal government's general fund to the Social Security trust funds to cover any payroll tax amounts not collected, according to Mnuchin. That would likely add more to the nation's debt, though.

Here are some numbers on the treasury from Datalab:

In 2019, the federal government collected $3.5 trillion in revenue. 

In 2019, the federal government spent $4.4 trillion. 

In 2019, the federal government spent $984 billion more than it collected, resulting in a deficit. 

By the end of 2019, the government had $22.7 trillion in federal debt. 

To pay for a deficit, the federal government borrows additional funds, which increases the debt. The total debt that the federal government owes is essentially the accumulation of deficits over time, minus debt repaid by any surpluses, plus debt that the Treasury owes to other parts of the federal government. Other activities contribute to the change in federal debt, such as changes in the Treasury's operating cash account and federal student loans.

And this was before all the additional trillions of dollars so far from the pandemic. So, where will the money from Social Security come from? And what will happen if the cuts are made permanent?

From CNBC:

President Donald Trump’s executive order calling for a payroll tax holiday is prompting many to ask: What does that mean for the future of Social Security?

Whether the president’s move ultimately will hurt the program depends on who you ask.

Payroll taxes are taken from both employers and workers to help fund government programs such as Social Security and Medicare. Currently, employers and workers each pay 6.2% towards Social Security, or 12.4% total. The Social Security payroll tax phases out for incomes above $137,700.

Trump announced on Saturday that he plans to put a temporary payroll tax holiday in place for workers who make less than $100,000 per year. The tax suspension would likely run from as soon as August through the end of the year, he said.

“If I’m victorious on November 3rd, I plan to forgive these taxes and make permanent cuts to the payroll tax,” Trump said.

The move comes as Covid-19 has made Social Security’s already limited funds more vulnerable. 

The Social Security Administration’s most recent projections indicate the program’s combined trust funds will run out in 2035, at which time 79% of promised benefits will be payable.

But that estimate was put out in April and did not take into account the effects of the pandemic. Other more recent estimates have predicted the funds now will likely run out sooner under current conditions, in 2032 or 2028.

Trump’s payroll tax cut, if made permanent, would make that happen even quicker, as soon as 2023, said Nancy Altman, president of Social Security Works, an advocacy organization. 

Meanwhile, the Trump administration is arguing that the payroll tax cut would not affect the program’s funding.

“There would be an automatic contribution from the general fund to those trust funds,” Treasury Secretary Steven Mnuchin said in an interview on Sunday. “The president in no way wants to harm those trust funds, so they would be reimbursed, just as they’ve always been in the past when we’ve done these types of things.”

But Altman said she does not believe that would work.

Social Security currently has reserves of $2.9 trillion. Meanwhile, payroll taxes bring in $1 trillion per year.

I read somewhere that the current spending is also $1 trillion dollars a year. So, with no money coming in, the fund will dry up in three years.

“If he throws it until the end of 2023, then benefits will stop, because there’s not enough money in the accumulated reserve,” Altman said.

Using general revenue would take an act of Congress, she said.

″[Trump] certainly will make the case that he has the power,” Altman said. “It’s not clear to me that he has.”

There's more from this article, so be sure to check it out.

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