Social Security and Medicare Are Progressive Taxes

Social Security and Medicare Are Progressive Taxes

The federal government has a few other smaller sources of revenue. It imposes an excise duty – that is, a tax on a particular product – on gasoline, tobacco and alcohol. As a percentage of GDP, the amount collected by these taxes has remained almost constant over time, rising from about 2 percent of GDP in the 1960s to about 3 percent in 2012, according to the Congressional Budget Office, a nonpartisan organization. The government also levies an inheritance and gift tax on people who pass on large amounts of assets to the next generation – either after death or for life in the form of gifts. These inheritance and gift taxes levied about 0.2% of GDP in the first decade of the 2000s. Other federal taxes, which are also relatively low, include tariffs on imported goods and fees for inspections of goods imported into the country. Opponents of progressive taxation are generally proponents of low taxes and, therefore, minimal government services. Personal and corporate income tax, as well as inheritance tax, are all progressive. In contrast, excise taxes are regressive, as are payroll taxes for social security and health insurance. Regressivity can be observed in a certain income zone (Figure 2). Taxes can be described as progressive, proportional, or regressive, depending on how the marginal tax rate you pay at different income levels changes, as described in the following feature. Marginal tax rates are closely linked to the concept of tax brackets. An excise duty increases the price of the goods or services taxed in relation to the prices of other goods and services.

Households that consume a larger part of the taxed good or service as a proportion of their total consumption are therefore more exposed to the tax burden with this change in relative prices. The regressivity of excise duties is mainly the result of this effect on relative prices, as alcohol and tobacco account on average for a decreasing share of consumption as household income increases. On the positive side, a progressive tax system reduces the tax burden on those who can least afford to pay. This leaves more money in the pockets of low-wage earners, who are likely to spend all that money on essential goods while boosting the economy. A progressive tax is based on the solvency of the taxpayer. It imposes a lower tax rate on people with low incomes than on those with higher incomes. This is usually achieved by creating tax brackets that group taxpayers by income bracket. A uniform income tax system levies the same percentage of tax on everyone, regardless of income.

In the United States, the payroll tax that funds Social Security and Medicare is often considered a flat tax because all employees pay the same percentage. However, this tax has a ceiling. For 2021, payroll tax will not be levied on revenues over $142,800. (For 2022, tax will not be levied on income over $147,000.) This makes it a flat tax only for people who earn less than that amount. Taxpayers who earn more than $142,800 a year pay a lower percentage of their total income in payroll taxes. This makes it a regressive tax. Specific sources of tax revenue vary widely between state and local governments. Some states rely more on property taxes, others on sales taxes, others on income taxes, and others on federal government revenues. The payroll taxes that support Social Security and Medicare are designed in different ways. First, payroll taxes are levied on Social Security at a rate of 12.4% up to a certain salary cap, which was set at $117,900 in 2014. Medicare, on the other hand, pays for health care for the elderly and is set at 2.9%, with no upper cap. In both cases, employers and employees share the payroll tax.

An employee sees only 6.2% deducted from their Social Security paycheck and 1.45% from Medicare. However, economists are quick to point out that half of the employer`s taxes are likely to be passed on to workers in the form of lower wages, so that in reality, the employee pays all payroll taxes. The second largest source of federal revenue is the payroll tax, which provides funds for Social Security and Medicare. Payroll tax has been steadily increasing over time. Together, income and payroll taxes accounted for about 84% of federal tax revenues in 2012. Although income tax revenues represent more total revenue than payroll tax, nearly three-quarters of households pay more payroll tax than income tax. Payroll taxes that support Social Security and Medicare are regressive because low-income groups face higher average rates. The poorest 50% have an average payroll tax rate of 6.8%, while the average rate for the richest 0.01% is only 0.08%. This is due in part to the wage cap on the 12.4% Social Security tax levied on wages up to $142,800.

Overall, however, the progressivity of income tax more than offsets the regressivity of payroll tax. The regressive nature of payroll taxes is the result of two factors. First, the Social Security portion of payroll tax is subject to a cap: in 2020, individuals will only pay tax on their first income of $137,700. Second, households with higher incomes receive more of their income from sources other than wages, such as capital gains and dividends, which are not subject to payroll tax, compared to low-income households. However, since wages increase as a proportion of income above the first four quintiles of the distribution, payroll taxes are slightly progressive until a high level of income is reached. The rationale for a progressive tax is that a flat-rate tax percentage would be a disproportionate burden on low-income people. The amount of dollars owed may be smaller, but the effect on their real purchasing power is greater. Taxes can be classified as progressive, proportional or regressive, depending on how their marginal tax rate changes as income increases. .

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