You Ask, We Answer: Why Are Payroll Taxes Going Up?


President Obama entering the White House/ White House flickr

A number of our Facebook fans expressed concern last week when they discovered that payroll taxes would be increasing in the wake of fiscal cliff negotiations. One person wrote in dismay, "What about all the months of discussion that increasing taxes on the middle class would hurt the economy?"

We understand your dismay. Here's what happened.

First of all, payroll taxes are special deductions from your paycheck that directly fund the Social Security and Medicare programs. Typically workers pay 1.45 percent of their wages into Medicare and 6.2 percent into Social Security (though the Social Security tax applies only to the first $113,700 of wage income). Since 2010, there has been a payroll tax "holiday" in effect: For two years workers paid 4.2 percent of their paychecks into Social Security instead of the usual 6.2 percent. That rate reduction was meant to stimulate the economy by putting more money in the pockets of working Americans. But that tax holiday was scheduled to expire at the end of 2012. Since lawmakers did not extend it in the fiscal cliff deal, all workers will now see smaller paychecks – on average a loss of about $40 from each biweekly paycheck, according to the White House. And as our Facebook fan noted, that will indeed have a negative effect on the economy, because consumers will spend less money.

While this sounds like nothing but bad news, some people view the end of the tax holiday as a good thing. That's because the tax holiday reduced revenue into the Social Security program. As a result, for the past two years, payroll tax revenue was not sufficient to cover the costs of Social Security, and the program temporarily contributed to the federal budget deficit. Now that the tax holiday has expired, our payroll taxes will once again cover the full cost of the Social Security program. For more detail about the financial health of Social Security, check out this fact sheet.

This post was corrected at 3:47pm on Jan. 7. The Social Security taxable maximum was previously listed as $110,100; the new maximum for 2013 is $113,700.