Social Security: The Working Class Tax
The major media, including television and newspaper, regularly employ buzzwords that suggest that income taxes are excessive. ‘Tax burden’ and ‘tax relief’ are two phrases that are frequently employed in this regard. What is the underlying message of these seemingly innocuous phrases?
The word ‘burden’ implies excessive struggle and hardship. It evokes the image of an individual struggling under a heavy load. The word ‘relief’ suggests saving someone from this hardship. Relief comes after a disaster or in times of great need. It may evoke the image of the cavalry saving the settlers from an Indian attack.
In a more modern context, the image might be one of international assistance coming to the aid of a community struck by a natural disaster, such as an earthquake or tsunami. Direct Relief International is the name of a global organization that employs the word ‘relief’ in this manner. As such, ‘relieving’ someone of a ‘burden’ is likely to evoke an image of someone lightening an unbearable load by removing some of it.
Politicians and the Media regularly employ these phrases in the ongoing debate over the wisdom of raising or lowering income tax rates. Most often these terms are used to justify tax cuts for America’s highest wage earners. These terms were first employed during the Reagan and Bush era to justify their proposed ‘tax relief’ from the ‘tax burden’ on the wealthy. The same phrases have continued to be part of the Media characterization of every political discussion regarding appropriate income taxes.
The Media rarely, if ever, employs the terms ‘tax relief’ and ‘tax burden’ in regard to those citizens at the lower end of the income scale. The underlying assumption in these arguments must be that the wealthy pay an unfair share of their income in taxes. This line of reasoning suggests that the American tax system places an unfair ‘burden’ on the wealthy. From this perspective, the more prosperous members of society require ‘tax relief’ to save them from the hardship of this excessive load.
The intent of this article is to dispel these Media myths. These misconceptions are not factually based, but rather rely upon innuendo and half-truths. We will carefully analyze current data and provide easily comprehensible graphs in support of our claims. The following 3 paragraphs will preview our 3 central arguments.
Initially, we argue that the notion that the federal income tax claims a higher percentage of a wealthy citizen’s income is simply untrue. Although the personal federal income tax is supposedly progressive, the functional reality of the federal tax system undermines any reasonable claim to such progressivity. When Social Security Taxes and the Mortgage Deduction are taken into account, the tax percentage rate is fairly equivalent (about 30%) for all income levels, except the poorest wage earners.
Although the percentages are roughly equal, it is true that wealthier Americans pay a larger dollar amount in federal income taxes. However, when we examine personal disposable income across the income spectrum, a second issue emerges. It is evident that these larger dollar amounts are in no way burdensome. The wealthy have an enormous amount of disposable income left over after tax and mortgage payments. This is especially true when compared with the disposable income of middle and lower class wage earners. In other words, the quantitative ‘burden’ on the upper tax brackets does not indicate a need for tax relief.
And finally, we suggest that when we consider the notion of a ‘burden’ on American taxpayers, we should look to the opposite end of the tax bracket. By any functional measure, the wage earners on the lowest rungs experience the greatest tax burden. If anyone deserves relief, it is this segment of society.
Read on for details.
(Note: All the percentages and values employed in the computations to produce the graphs and tables in this article come from the 2013 Federal Income Tax Form.)
Progressive Income Tax
In general there are three types of income taxes: Progressive, Regressive, and Flat.
• Flat taxes: everyone pays the same percentage of their income to the Government, whether rich or poor.
• Progressive Taxes: those who earn more money pay a higher percentage of their income in taxes than those who make less money.
• Regressive Taxes: those who earn less money pay a higher percentage of their income than those who make more money.
An examination of the design of the Federal Income Tax reveals its intentionally Progressive nature. The chart below displays the progressivity of the American personal income tax.
Percentage of Income to Federal Income Taxes (Without Write-offs)
The red bars represent the percentage of an individual’s annual income that is paid in Federal Income Taxes. The rising trajectory of the red bars indicates that those earning more are expected to pay a higher percentage of their annual earnings in Income Taxes. The chart provides strong visual evidence that Federal Income Taxes are indeed designed to be Progressive.
Let us briefly examine how we came up with the numbers behind the graph.
Graduated income brackets in the American tax system generate the progressive curve that is reflected in the chart. There are 7 tax brackets, which begin at 10% and rise gradually towards the top bracket, which is 40%. The income earned in each tax bracket is taxed at a different percentage. For instance, income below $9K is taxed at 10%. In the next bracket, income between $9K and $36K is taxed at 15%; income between $36K and $88K at 25%; between $88K and $183K at 28%; and so forth. Income in the top tax bracket of $400K and above is taxed at 40%.
A common misconception is that those in the highest tax bracket pay 40% of their annual earnings in Federal Income Taxes. That is simply not the case. Due to the graduated nature of the Federal Income Tax, the first $9K of income is taxed at 10% no matter how much money an individual earns in a year. The next $27K of annual income is taxed at 15%. The next $48K is taxed at 25%, and so on through each income bracket. Only income earned above $400K is taxed at the 40% rate. Due to the graduated nature of the taxes, the million-dollar-a-year earner actually pays about 34%, not 40%, on his annual income.
We made one adjustment in our chart to reflect functional tax reality. All individual taxpayers are entitled to the automatic standard deduction combined with the personal exemption. In other words, everyone has $10K automatically taken off their income, no matter how much they earn in a year. This is why individuals who earn less than $10K/year pay no Income Tax. The figures that generate the chart reflect this $10K adjustment.
While Federal Income Taxes are arguably progressive, they are just one type of Federal Tax. The picture is incomplete until we also consider the effect of the Social Security Tax on wage earners. When the Social Security tax is included, the claims of progressivity within the American federal tax system take on an entirely different light.
Regressive Social Security Tax
Not only do most Americans pay Income Taxes to the Federal Government, many also pay Social Security Taxes. While Income Taxes are progressive, Social Security Taxes are regressive. In other words, those who earn the least amount of money pay the biggest percentage of their income in this type of tax and vice versa. The following graph illustrates the extreme regressivity of the Social Security Tax.
Percentage of Income to Social Security Taxes
The red bars represent the percent of income that the Social Security Tax takes from an annual income. It is a flat tax for those with incomes up to $117,000 per year (as of 2014). Everyone in this category pays the same percentage — 15.3% off the top. After this point, there is a cap on the Social Security tax. In other words, no Social Security Taxes are levied on income over $117K per year. Therefore those earning over $117K per year pay a declining percentage of their income towards Social Security. Someone earning one million dollars a year pays the same amount in Social Security Taxes per year as does the much less affluent individual earning $117K per year.
No matter how small the paycheck, there are no allowable deductions. A full 15.3% of the first $117K of income is funneled to the government for Social Security Taxes. Conversely, the individual earning a million dollars a year in salary only pays SS taxes on the first $117K. Consequently, this taxpayer contributes less than 5% of his income towards Social Security Taxes.
Notice how the line associated with the red bar starts high and then fades in significance. It is visually apparent that the wealthiest segment of society pays the least percentage of their income towards Social Security Taxes, while those collecting the smallest paychecks pay the highest percentage.
In summary, the Social Security Tax is clearly regressive. It is applied on a sliding scale that benefits only the wealthy. Those earning the least amount of money pay the greatest percentage of their income in Social Security Taxes, while those earning the most pay the least. Income Up: Social Security Tax Rate Down; and vice versa.
Social Security: The Working Class Tax
This discrepancy between the Taxes paid by the Rich and Poor is aggravated when one considers that only the Working Class is subject to Social Security Taxes. In this context, the Working Class includes those who run their own business and both salaried and hourly wage earners.
Many forms of income are not subject to Social Security Taxes. These include:
• Stocks earnings
• Interest earnings
• Property Sales
• Corporate Profit
In other words, when one’s assets (including money, stocks, or property) do the work, no Social Security Taxes are paid. Of course, the wealthier segments of our country are the ones most likely to be earning money in this fashion. It is primarily these individuals who have sufficient assets to generate income. Reiterating for retention: Asset Income is exempt from the Social Security Tax.
Social Security Taxes are only applied when a human being’s body and soul are engaged in some type of productive behavior. In this sense, the Social Security Tax should be called the Working Class Tax. Those who earn money in ways other than work pay no Social Security Tax whatsoever.
Let us summarize and refine our findings thus far. In terms of the Federal Taxes we have discussed, there are 2 general types of income — Worker Income and Asset Income. We have also discussed two types of federal taxes — Personal Income Tax and Social Security Taxes.
Income Tax is applied to both of these forms of Income. Income Taxes are Progressive. Income Up: Income Tax Percentage Up, and vice versa.
The Social Security Tax is only applied to Worker Income. Social Security Taxes are Regressive. Income Up: Social Security Percentage Down; and vice versa. Asset Income, while subject to Income Taxes, is exempt from this Working Class Tax.
The Employer Contribution, the Hidden Tax
The astute reader might have wondered why the number employed for Social Security Taxes is 15.3%, when the actual payroll deduction is ‘only’ 7.65% (6.20% for Social Security plus 1.45% for Medicare). While only 7.65% is taken from direct wages for Social Security taxes, the employer must match this amount. [The self-employed pay the full 15.3 % flat tax.]
The employer’s matching share of these taxes is mischaracterized as a contribution. In fact, the employer’s ‘contribution’ most often is a hidden tax on the worker. It does not typically come from the Employer’s savings account or college fund, but rather this tax is paid from his anticipated labor costs. If the business owner doesn’t choose to accept a reduction in profits or to pass these costs on to the consumer, then labor will bear the brunt of the owner’s ‘contribution’.
One significant example of this hidden tax on labor is the effect on an employer’s willingness to provide raises to his workers. Employers typically perceive their matching contribution to Social Security taxes as a labor cost. This labor cost significantly cuts into the funds available to raise wages. No matter how generous the Employer is, s(he) must take this hidden tax into account when doling out bonuses or raises.
Due to matching tax contributions, the Employer pays far more for his employees than their salary or hourly rate indicates. Roughly speaking, it costs the Employer $8.61/hour for the minimum wage, $8/hour, worker. As far as the Employer is concerned, this elevated amount is the actual cost of the employee — not the amount stated on the employee’s paycheck. As such, the Employer Contribution can be viewed as a hidden tax that is ultimately born by the Employee’s income.
The Social Security tax provides a double whammy. First, it is a direct payroll tax that can’t be avoided. Second, the hidden tax contributes to the employer’s labor costs, which impacts the ability to give raises. In other words, the minimum wage worker only takes home $7.39/hour of the $8.61/hour it costs the employer to pay him or her.
For this reason, we have utilized 15.3% rather than 7.65% when speaking about the Social Security Tax rate. This is the value that every employer must take into account when paying his employees.
Personal Income Tax + Social Security Tax = Federal Tax
American Citizens typically pay two types of taxes on their wages to the Federal Government — the Personal Income Tax and Social Security Taxes. Let us combine these two types of taxes to see what they reveal. The red bars in the following graph represent the percentage of Income going to the Federal Government when the Social Security Tax is added to the Income Tax.
Percentage of Income to Taxes: Social Security + Income Tax
Adding the regressive Social Security Tax to the progressive Income Tax, clarifies the actual tax burden on wage earners. Two significant points emerge: 1) Even the poorest wage earners pay almost 15% of their income in federal taxes; 2) The tax burden of the wealthy becomes far less progressive when we consider the combined effect of the 2 taxes. While the tax burden represented by the combination of these taxes is still moderately progressive, the rising curve is much flatter (hence less progressive) than when the Income Tax graph is considered alone.
This analysis shows why the Social Security Tax is regressive. The following article “Is the US Tax system really Progressive” illustrates how the wealthier members of our society, while complaining of an unfair tax burden, are actually making out like bandits.
Read “Brief History of Social Security” to see how our Social Security system benefits any Americans who have experienced hardships that leave them without income, not just the working class. Why then should those who actually work for a living assume the entire social burden for this unfortunate sector of society?
These articles are part of “Tax Justice”, a larger work aimed at exposing the many misconceptions surrounding taxes and social assistance.