What Is the Payroll Tax Cap?
The payroll tax cap references an element of the Federal Insurance Contributions Act (FICA) tax. This is a tax imposed on all U.S. employees and their employers to fund Social Security and Medicare. Social Security funds are paid out to retirees according to the amount they paid into the program during their working careers as a means of financially supporting them during this period of their lives. Similarly, the Medicare program provides medical insurance benefits.
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How Social Security Works
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The money deducted from your paycheck does not go into an account from which you draw funds after you retire. That money goes to fund retirees who currently are drawing on Social Security benefits who previously paid into it during their working careers. The money they invested went to pay for retirees during their time in the workforce. This practice goes back to the days of Franklin Delano Roosevelt, who originated this program to help poor retirees. In theory, the system will continue to work as long as the working population is large enough to compensate the retired population.
Payroll Tax Cap
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Only earned income is taxed for Social Security and Medicare. In 2010, the percentage at which a worker’s income taxed is 12.4 percent. This amount is shared between employees and employers, meaning that as a worker you only see 6.2 percent of your gross income taxed under FICA. Your employer pays the additional 6.2 percent, (although it is assumed the employer must calculate this when hiring new employees). As of 2010, this tax applies only to the first $106,800 that you earn. This is the payroll tax cap. Anything you earn beyond this amount is not taxed as part of FICA.
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Regressive Tax
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When a tax is applied uniformly across a population, it is considered regressive. Unlike income tax, which allows for deductions that can lower your taxable amount, a regressive tax is set firm. This means that it affects low-income workers more than high-income workers. Sales taxes, gas taxes and cigarette taxes are all considered regressive taxes since they apply to everyone at the same rate despite their level of income. If you earn $2,500 a month and spend $500 on groceries with a 5 percent sales tax, $25 is spent in tax, which is 1 percent of your monthly income. If your neighbor earns $5,000 a month and spends the same amount on groceries, only one-half of a percent is spent on sales tax. This same consequence is in effect with FICA.
Proposals
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There are numerous arguments for raising the payroll tax cap, including the fact that those who earn more money will pay a fairer amount in FICA compared with those who never reach the tax cap amount. The extra amount collected could possibly keep Social Security longer. It is also argued, however, that the raised taxable level will adversely affect small businesses that create jobs that contribute to the number of people paying FICA. The result could be that fewer jobs would be created, causing a fewer number of people paying into the account.
Social Security Trust Fund
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The U.S. Treasury has two Social Security trust funds: the Old-Age and Survivor’s Insurance (OASI) Trust Fund, and the Disability Insurance (DI) Trust Fund. Social Security taxes are collected and deposited into these accounts, and benefits are paid from them as well. The money that is collected that is in excess of what is paid out in benefits is invested in special Treasury bonds that are guaranteed by the U.S. government.
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- Photo Credit A young woman holding a pen, doing her taxes image by Christopher Meder from Fotolia.com
