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Reform the Payroll Tax
February 11, 2003
By John Mattar

As the Republicans continue to push proposals for tax cuts, progressives need to reach consensus on fundamental tax reforms in order to provide a unified counter to the Republican proposals. It is one thing to criticize Republican tax proposals. It is another to offer concrete alternatives.

For far too long, the Republicans have dominated discussion of tax rates and tax cuts. They have consistently misled the American people by focusing on the personal federal income tax, when in fact it is the payroll taxes that have the greatest impact on lower to middle income earners. Progressives would focus tax cuts on the lowest income earners. Who could possibly need more tax "relief" than those at the lowest income levels?

Progressives should rally around a set of basic, structural tax reforms aimed at restoring progressivity to taxation. We need to present a straightforward, compelling agenda of tax reform to the voting public. We need to make clear to working Americans that their interests would be well served by progressive tax reform. We need to make bold, focused, and achievable proposals for reform. We need to ask upper and upper-middle class Americans to forgo any tax cuts and to in fact pay more. We need to recapture the public agenda on taxation.

There should be two basic principles for distributing the tax burden.

First, tax policies should maximize the rewards of work and earnings, especially at lower income levels.

Second, earnings should be taxed progressively. Those who earn more in absolute terms can afford to pay more in relative terms. This does not mean that taxes should ever be oppressive to the point of discouraging work. It does mean, however, that lower-income earners should be taxed at lower rates than higher-income earners.

The current structure of federal taxation does not meet these goals.

Much debate over taxes focuses on the federal income tax. This is misleading, primarily because the payroll taxes that have the greatest impact on low to middle-income workers. Additionally, the Social Security tax is one of the most regressive taxes in the county.

Consider the combined impact of the Social Security tax and the Medicare tax (the payroll tax). Wage earners pay both of these taxes from the very first dollar earned. The Social Security tax is 6.2% and the Medicare tax is 1.46%, for a total of 7.66%. That is significant to workers earning low incomes. If a person earns just $10,000 per year, he or she pays approximately $766 dollars a year in these payroll taxes. Someone earning just $20,000 per year pays approximately $1532 per year. This is a significant amount of money for someone living from paycheck to paycheck.

Two Fundamental Reforms

Two fundamental reforms could go a long way in addressing the inequities of the current tax system.

1) Provide a rebate of payroll taxes each year to all workers earning less than $20,000. This could be done on a sliding scale where those making less than $15,000 get all of their payroll taxes back, while those making between $15,000 and $20,000 get some portion of their payroll taxes back. Such a reform would provide a permanent, large-scale, working-class tax cut to those who need it most. It is also a consumer-oriented tax cut, providing sustained stimulus to the economy. The next proposal can provide the funding for this tax cut.

2) Eliminate the "earnings cap" on the Social Security tax. People making more than $80,400 per year pay no additional Social Security tax on earnings above $80,400. Someone making $80,400 per year pays - in absolute terms - as much Social Security tax as someone earning $100,000, $150,000, or even $1,000,000 per year. In relative terms, workers earning $80,400 or less pay a higher percentage of their earnings in Social Security taxes, making Social Security a truly regressive tax. The less you earn, the greater the percentage you pay in tax. This is exactly the opposite of the way taxes should work. This aspect of the Social Security tax is almost never discussed in American politics. (Republicans who champion a flat tax should be reminded that progressives might call their bluff and propose a truly "flat" Social Security tax on all income. )

The table below shows the approximate "effective" Social Security tax rate for various income levels.

Annual Earnings ($)
Social Security Tax Paid ($)
Social Security Tax Rate
10,000
620
6.2%
20,000
1,240
6.2%
80,400
4,984
6.2%
150,000
4,984
3.3%
250,000
4,984
2.0%
500,000
4,984
1.0%
1,000,000
4,984
0.05%
5,000,000
4,984
0.01%

Citizens for Tax Justice estimates that the elimination of the "earnings cap" would generate an estimated $52.8 billion in additional annual revenue (year 2000). That could pay for a full rebate of the payroll tax for up to 34.4 million workers earning $20,000 each year .

These proposals are not only good policy, they are also good politics. Most people earn less than $80,400 per year. Many of them are unaware of the "earnings cap" on Social Security taxes. It is time for an honest debate about the real impact of taxes on "working families".

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