What is Payroll Tax? Who Pays for It?

When Congress failed to pass a second stimulus bill earlier this month, President Donald J. Trump took matters into his own hands. The president signed a series of executive orders designed to aid Americans without congressional intervention. One of Trump’s most notable moves was enacting a payroll tax holiday from September 1st through the end of the year.

Trump hopes that a payroll tax deferment will increase wages and bring relief to struggling Americans, but critics think the move could have some negative ramifications. Before getting into all of that, however, it’s important to understand exactly what payroll tax is, who bears the cost, and where those tax dollars are spent.

What is Payroll Tax?

Broadly speaking, payroll taxes are withheld from employee earnings and sent by employers to the government. In the U.S., payroll taxes cover the costs of Medicare, Social Security, and unemployment insurance. If you’ve ever looked at a paystub, you’ve probably seen the itemized deductions for each service. Employers pay 6.2 percent of their salary toward Social Security and 1.45 percent to Medicare and withhold the same amounts on every employee’s paycheck. Employers also pay an additional 0.6 percent toward unemployment insurance.

The concept of a payroll tax is pretty simple. Workers have money deducted from their paychecks and directed into services that those workers will rely on after retirement. The fact that payroll taxes are spent on specific government programs largely differentiates them from other tax dollars, which are spent with more discretion. While the federal government collects payroll taxes everywhere, some state governments take a piece of the pie for infrastructure projects as well.

Payroll taxes are a major source of revenue for the government. The Congressional Budget Office reported that these taxes brought in nearly $1 trillion for Social Security alone in 2019.

The Impact of Trump’s Payroll Tax Holiday

In principle, a payroll tax deferment could put more money in workers’ pockets this year. The median household income is roughly $50,000, and the employee payroll tax rate is 7.5 percent. A four-month holiday from this tax would equate to almost $1,000 in savings by the end of the year. Ideally, that money could replace a second stimulus check of $1,200. Unfortunately, it’s not that simple.

That means that many employers may still withhold payroll taxes, despite the intention of Trump’s executive order. Otherwise, business owners will need to pay four months’ worth of taxes out of their own pocket when filing.

“If businesses did pass the tax holiday funding along, it is doubtful that most households would spend the money, figuring that they would have to pay the money back three months later,” Steven Stanley, chief economist at Amherst Pierpont, told MarketWatch. 

The Bottom Line

Trump has indicated that he would make the payroll tax cut permanent if he wins re-election, but that could have disastrous effects on Social Security. All in all, the payroll tax is levied to support critical government programs, and the benefits of a tax holiday are likely limited. The tax holiday begins September 1, so employees should discuss what may change with their employers before then.