Why Tax Work? A Close Look at the Payroll Tax Turns Conservative Rhetoric on Its Head

Article excerpt

Three-quarters of the U.S. public believes our tax system needs a major overhaul, and so far, conservatives seem to have a lock on the issue. As House minority leader Richard Gephardt concedes, "[Voters] are very upset about their own economic situation and about taxes. And the Republican message ... is about taxes." It's time Democrats responded with a bold tax plan of their own.

While House majority leader Dick Armey and his Republican colleague Billy Tauzin have been barnstorming the country extolling their flat tax and consumption tax proposals, Democrats have mostly been sitting on the sidelines, offering timid proposals that amount to little more than tinkering with the current system. In the process, they have overlooked a major opportunity to seize the offensive and re-orient the tax debate toward progressive ends.

The best thing that could happen to our tax code is a substantial reduction in the payroll tax, which is now the largest and most damaging tax on working Americans. With all the partisan rhetoric about the value of hard work, it's amazing that the one tax that falls exclusively on work and wages has gotten so little attention. Yet payroll taxes impose a huge and unfair burden on low-income workers and small businesses, hindering job creation and cutting into take-home pay.

Instead of taxing payrolls, America should tax pollution. Adopting market-based policies to clean up the environment could yield hundreds of billions of dollars in new public revenue. Using this money to cut existing payroll taxes would strengthen our economy, boost wages and job creation, fix our troubled tax system and protect the environment, all without raising the deficit. What more could Americans want from a tax plan?

One would never know it from all the partisan skirmishes over income tax cuts, but more than 70 percent of U.S. families now pay more in payroll taxes than in federal income taxes. Although payroll taxes-listed as "FICA" on paychecks -- are split between employers and employees, most economists agree that the full 15.3 percent burden ultimately falls on workers, through reduced wages or benefits. There are actually two distinct payroll taxes: a 12.4 percent one to fund Social Security; and a 2.9 percent one to fund Medicare.

While income tax rates have declined for most families in recent decades, payroll taxes have increased dramatically. From 1960 to 1995, the percentage of government revenue derived from payroll taxes went up from 12 to 33. In other words, Congress has quietly legislated a fundamental shift toward payroll taxes over the past thirty years; these now provide nearly as much federal revenue ($506.8 billion) as the income tax ($737.5 billion).

That payroll taxes worsen inequality is undeniable; in fact, they embody all the negative features of a flat tax, and then some. Unlike the progressive income tax, which taxes higher incomes at higher rates, the payroll tax applies a uniform rate to all workers regardless of income. And like the leading flat-tax proposals, payroll taxes apply only to wage income, thus exempting all other forms of income (interest, dividends, capital gains, etc.). But not even the flat-tax proponents would be so devilish as to propose a tax that kicks in from the very first dollar earned and sets a ceiling on the amount of wages to be taxed. The payroll tax -- the Social Security portion of which is now capped at $68,400 -- does both.

The cumulative effect of these features is a grotesquely skewed tax that allows the wealthy to pay a much lower effective rate than the vast majority of working Americans. For instance, a worker making $30,000 a year will pay the full 15.3 percent, but his boss making $300,000 a year will pay only 5.7 percent. If the Democratic Party is looking for levers to reverse growing inequality, this is the place to start.

A closer look at the payroll tax also turns the underlying conservative tax rhetoric on its head. …