What are the major federal payroll taxes, and how much money do they raise?
Payroll taxes are levied to finance Social Security, the hospital insurance portion (Part A) of Medicare, and the federal unemployment insurance program. Revenue totaled just over $1 trillion, or about 6 percent of GDP, in fiscal year (FY) 2015 (figure 1).
Social Security, or more formally, Old-Age, Survivors, and Disability Insurance (OASDI), provides benefits to elderly and disabled workers, their spouses, and surviving spouses or dependents. It is one of the largest items in the federal budget, with outlays of $897 billion in 2015.
Benefits are mainly financed by a payroll tax on cash wages up to an annual threshold indexed to average wage growth (table 1). In 2017, the maximum taxable wage was $127,200. Employers and employees each contribute 6.2 percent of the workers’ wages for a combined 12.4 percent—usually 10.6 percent for the OASI trust fund (retirement and survivors) and 1.8 percent for the DI trust fund (disability). The Bipartisan Budget Act of 2015 temporarily reallocated a portion of the OASI tax to the DI trust fund for 2016-2018 to shore up the DI trust fund, which faced insolvency. For those years, the combined employer and employee rates are 10.03 percent for OASI and 2.37 percent for DI. Most economists believe that the employer portion of the tax, just like the employee portion, is borne by employees in the form of lower compensation.
Over time, Social Security taxes have become a major share of federal revenues. When first collected in 1937, the combined payroll tax rate was 2.0 percent; it raised $765 million (about $12.6 billion in 2015 dollars). In 2015, OASDI taxes totaled over $770 billion and represented 23.7 percent of federal receipts.
The hospital insurance (HI) program, or Part A of Medicare, covers inpatient hospital visits and other health care services for the elderly and some others suffering from specified maladies. Federal costs for other parts of Medicare, such as Part B, which covers doctors’ and other providers’ fees, are not covered by payroll taxes but mainly by general revenues.
The HI program is financed mainly through payroll taxes on workers. Employers and employees each contribute 1.45 percent of the worker’s wages toward the HI trust fund for a combined rate of 2.9 percent (table 1). The cap on wages subject to the HI tax was removed in 1994. Also, beginning in 2013, single households earning more than $200,000 and married households earning more than $250,000 contributed an additional 0.9 percent of earnings over those thresholds (there is no employer portion for this “surtax”).
In 1966, the first year of HI tax collections, the combined tax rate was 0.7 percent, and collections totaled $1.9 billion (about $13.9 billion in 2015 dollars). In 2015, HI taxes surpassed $234 billion.
Unemployment insurance (UI) provides insured workers with benefits if they are involuntarily unemployed and meet eligibility requirements. Unemployment insurance programs are run by the states in partnership with the federal government. To finance benefits and program expenses, payroll taxes levied by both the states and the federal government are paid into a federal trust fund.
The federal payroll tax rate is 6.0 percent on the first $7,000 of covered wages, but tax credits reduce the effective federal tax rate to 0.6 percent. State unemployment tax rates and wage bases vary, but are usually below 4 percent and are on relatively low wage bases.
In 2015, federal UI taxes totaled about $51 billion.
Other Retirement Programs
A handful of other retirement programs are funded by payroll taxes. The largest of these is a retirement program for the railroad industry operated by the Social Security Administration, which functions similarly to Social Security. Retirement programs for federal employees absorb most of the rest of payroll tax receipts.
Office of Management and Budget. 2016. Budget of the United States Government, Fiscal Year 2017, Historical Tables. Table 2.4. “Composition of Social Insurance and Retirement Receipts and of Excise Taxes: 1940–2020” and Table 10.1 “Composition of Social Insurance and Retirement Receipts and of Excise Taxes: 1940–2020.”
Social Security Administration. “2017 Social Security Changes.”
Harris, Edward W. 2005. “Payroll Tax, Federal.” In The Encyclopedia of Taxation and Tax Policy, 2nd ed. Edited by Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle, 293–95. Washington, DC: Urban Institute Press.
Joint Committee on Taxation. 2016. “Overview of the Federal Tax System as in Effect for 2016.” JCX-43-16. Washington, DC: Joint Committee on Taxation.
Office of Unemployment Insurance. 2004. “Unemployment Insurance Tax Topic.” Updated July 10, 2015.
Social Security Administration. 2015. Annual Statistical Supplement to the Social Security Bulletin, 2015. Washington, DC: Social Security Administration.