Wednesday, December 9, 2009

Approaching a Tax Milestone

Copyright, The New York Times Company

On Thursday, the United States Treasury releases its monthly statement of receipts and outlays. If not tomorrow, the report may soon show that the payroll tax has, for the first time in history, become the single largest federal tax.

For decades, the individual income tax has been the federal government’s single biggest tax. It is a (complicated) function of each family’s income from wages, investments and other sources, and is summarized every April with our filing of the infamous “Form 1040.”

Although officially known as a “contribution,” the Social Security tax brings in almost as much revenue as the individual income tax, and is catching up. The chart below shows Treasury collections of the two taxes (in order to adjust for seasonality, the chart shows the sum over the previous 12 months).

Since the recession began, individual income tax collections have fallen to $890 billion from $1,186 billion, whereas Social Security tax collections (inclusive of the Medicare tax) have increased to $848 billion from $837 billion. Thus, personal income tax collections have been rapidly falling down to the amount collected in payroll tax.

All of this has happened despite the fact that the Social Security tax is levied at relatively low rates: It has just two brackets of about 15 percent and 3 percent (inclusive of the “employer contribution”). For this reason, many economists consider the payroll tax to be the quintessential “flat tax.”

European countries have long been familiar with having the payroll tax as their primary tax. France, Germany and Greece — to name a few — collect significantly more in their payroll taxes than they do with personal and corporate income taxes combined.

Several western European countries are (deservedly, or not) known for their generous safety nets and heavy tax burdens, but they have no monopoly on payroll-tax primacy. The Czech Republic’s government is known for its free-market orientation, and it collects almost twice as much from payroll taxation as it does from personal and corporate income taxation combined.

That raises an interesting question for the United States as it considers a larger, and perhaps European-like, role for its government.

Will it be Democrats who first harness the revenue-collection power of the payroll tax? Or will Republicans appreciate its favorable incentives?

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