As shown in my prior post and the spreadsheet attached to it (now downloadable, my bad), a hypothetical couple age 67 and earning $75,000 per year would pay little more than one-third the federal, state and local taxes as a young working couple with the exact same income. Even though, to the extent the two couple’s non-money situations differ, the senior citizens were better off. Based on the percentage difference, senior citizens in New York City do even better relative to young people on New York’s state and local taxes than on federal taxes. I’ll discuss state and local taxes in my next post. For federal taxes, my hypothetical older couple, the Senior Voters, would owe $6,104, or 8.1% of their income. And my hypothetical young couple, Young and Younger Hopeful, would owe $16,409 in federal taxes, or 21.9% of income. Adding a one-year-old “Baby Hopeful” would cut the federal bill only slightly, to $14,914 or 19.9% of income. Eliminating Ms. Hopeful’s job and cutting the couple’s income to $50,000 per year would reduce the federal tax burden to $9,251 (18.5% of that reduced income), still more than the Senior Voters at $75,000 in income. The rest of the post shows how this is so.
For the federal income tax, although the two couples start out with the same income of $75,000, the Senior Voters have a taxable income of $45,700 while the Young Hopefuls have a taxable income of $54,467. The first $10,400 in Social Security income is considered non-taxable, and this accounts for most of the difference. Note that the last I read about this, that amount was not being adjusted for inflation, and so drops in value every year. That break may be worth very little when the Young Hopefuls are collecting Social Security, if they get it. Next, because the Senior Voters were age 65 or older their standard deduction is worth more — $12,300 for the two of them, compared with $10,300 for the Hopefuls. The idea is that those over age 65 are retired, no longer earn wages, and need all the help they can get. Note that under current law, without any future benefit reductions that some believe are necessary, the Hopefuls are not eligible for full Social Security benefits until age 67, not age 65. As a result of these two differences, the Senior Voters would own $6,104 in income taxes, while the Young Hopefuls would owe $7,431. Add a “Baby Hopeful” and the Young Hopefuls would owe $5,936, about the same as the Senior Voters.
The big difference, however, is the payroll tax. In a nutshell, the Senior Voters do not have to pay any payroll taxes on their income, because only work earnings are subject to the tax, not retirement earnings. Like most Americans, on the other hand, the payroll tax actually costs the Hopefuls more than the income tax. For Ms. Hopeful, an employee, the tax rate is 6.2% of her pay for Social Security and 1.45% for Medicare, for a total of 7.65% of her earnings, with her employer also kicking in the same amount. Since Mr. Hopeful is self employed, on the other hand, he has to pay both the employer and the employee share, for 15.3% of his total earnings. It should be noted that until the early 1980s payroll tax increases and Social Security retirement age changes to “save social security” the self-employed received a break. Both the employer and the employee each owed 6.7% of the employee wage in 1982, but the self-employed owed just 9.35%.
It is possible, moreover, that Ms. Hopeful is in reality paying both: if she needs the job more than her employer needs her, the employer can make her absorb the cost of the tax in lower wages. The payroll tax is only applicable to the first $90,000 in income, so for those earning more, the more they make the lower the share of their earnings the payroll tax takes. That’s true for the employer as well, and perhaps that’s one reason why employers are more likely to grant significant wage increases to those earning more than $90,000 than to those earning less than $90,000. Wage increases for the lower paid also increase the employer’s taxes.
Is it fair to criticize the fact that Young Hopefuls pay for Social Security and Medicare but don’t get it, while the Senior Voters get Social Security and Medicare but don’t pay for it? Is the payroll tax really a tax at all, or is it something like saving for retirement?
The Governments Division of the U.S. Census Bureau recognizes three main types of government revenue. The first is a Tax, which has no direct connection between what people pay into the government and anything they might receive from the government. The second is a Charge for services, such as a toll, transit fare, water bill, hospital bill, museum admission or golf course admission, etc. Here someone only pays if and when they receive a service. The third type of revenue is Insurance Trust. For insurance trusts, individual pay, or employers pay on their behalf, now with the expectation that they will receive a benefit later. Will the benefit be received later? Has money been set aside to pay for it, in a form that is in some sense real? Whether the payroll tax is a tax or an insurance payment depends on how much you trust the federal government.
For Social Security, both Democrats and Republicans have talked out of both sides of their mouths on that one. The Democrats will say the poor and middle class pay their share of taxes and more, because the payroll tax hits them harder than it does the affluent. But they will also say that people are entitled to the Social Security if they have paid in, even though the actual Social Security law makes plain that there is no entitlement to those benefits any more than there is to any other government program. For their part, the Republicans claim the payroll tax is an insurance payment when talking about taxes, then claim the rich are paying their share or more of the income tax. But they also say that the federal government will not be able to pay all the benefits now promised. I’ll write more about Social Security later on, but I think President Bush pretty much settled the issue when he admitted “we have a problem” but asserted that any solution should not include benefit reductions for those “at or over 55.” Clearly, for those who were not at or over 55 when he spoke the words, the payroll tax is just a tax, the revenues from which go to pay for those retired today and other current spending, not for themselves at some point in the future.
What about the Medicare portion of the payroll tax? Consider that our fictional couple, the Hopefuls, and a rising share of those in younger generations, do not have health insurance from their employer. And, like Social Security, Medicare will become increasingly unaffordable under current rules, making it very likely that any federal health benefits they receive in the future will be less generous. Since the money is used for health care today for others, rather than set aside in any real sense for themselves, I would say that the payroll tax for Medicare the young pay today is also a tax.
One thing is for sure — the payroll tax reduces the amount of money the Young Hopefuls have left to spend on other things. In my fictional example the payroll tax, other taxes, and accumulated home equity leave the Senior Voters with twice as much money after taxes and housing costs than our Young Hopefuls have. Even though the Senior Voters also have secure health insurance and retirement that our Young Hopefuls, and almost all young hopefuls today, lack.
So my bottom line stands. A couple of senior citizens the Senior Voters with $75,000 in income would owe $6,104, or 8.1% of their income, in federal taxes, while a young couple with the same income would owe $16,409 in federal taxes, or 21.9% of income. For no other reason than that the older couple is over 65 and the younger is not, and the older couple has pension and Social Security income while the younger couple has to work. Is that fair? Before discussing this, let’s consider state and local taxes in my next post.