Events in Context: Payroll Taxes, Social Security & COVID Relief
What's in this new executive order?
The economic fallout from COVID-19 is depriving Social Security of much-needed revenue, and now a series of executive orders might add to its financial burdens … or not. But why? The answer lies in how the program is funded.
If you’ve been to a Free the Facts event, you already know that our country’s entitlement programs operate on a pay-as-you-go system. Payroll taxes from current workers and their employers pay for the Social Security and Medicare benefits being collected by current retirees.
If you’ve ever earned a paycheck, you’ve seen this system in action. Every pay period your employer deducts 7.65% of your earnings (6.2% for Social Security and 1.45% for Medicare ss1), and sends it to the IRS on your behalf. This is what’s known as the “employee share” of payroll taxes.
Your employer then matches the tax you pay and sends a contribution equal to 7.65% of your earnings to the IRS. This is the “employer share” of payroll taxes.
Between you and your employer, that’s a total of 15.3% in payroll taxes going to Social Security and Medicare.
So what was announced?
Earlier this year, Congress passed the CARES Act. It allowed employers to delay paying the “employer share” of Social Security payroll taxes through December 31, 2020. Employers still have to pay the tax eventually, but the hope was that providing employers with some flexibility in when they paid the tax would help them cope with the financial strain caused by the pandemic.
In August, President Trump issued an executive order designed to offer employees the same kind of flexibility. Under the order, workers making $104,000 or less per year can defer paying the “employee share” of their Social Security payroll taxes from September 1 to December 31, 2020. In theory, this allows workers to get a larger paycheck now by delaying payment of their 6.2% Social Security payroll tax until next year.
What kind of relief could that provide? Well, let’s say you make $50,000 a year. Under the president’s executive order, your after-tax income would temporarily rise by $1,023 over four months.
Sounds pretty good. Are there any downsides?
Yes, and there are at least two of them you’ll want to understand.
First, it’s unclear whether most employees will be able to get the tax relief that the executive order provides. Ultimately employers are the ones responsible for withholding the “employee share” of payroll taxes and sending it to the IRS. In order for a person to take advantage of the flexibility offered by the president’s order, their employer has to be willing to implement a delay.
Second, just like employers under the CARES Act, employees can only defer paying their share of the payroll tax. Under the order, they would still have to pay the full amount they owe come January.
In a sense, workers making under $104,000 per year would get an interest-free loan from the federal government. But the loan would need to be repaid by April 30 of next year. And that’s only if their employer is willing to hold off and collect the deferred taxes later on.
It’s reasonable to think employers might have reservations about the logistics involved here. For starters, if they allow their employees to delay paying their Social Security payroll taxes, then employers would essentially be signing up for the potentially unpleasant task of collecting a worker’s payroll tax debt next year. That could mean withholding hundreds or thousands of dollars from an employee’s paycheck, which isn’t likely to earn you a “Best Boss” mug on your birthday.
And that’s the best-case scenario. Employers would also be on the hook for tracking down workers who deferred payroll taxes this year and then moved on to a new job before the tax debt came due. Depending on how many workers fall into that category, that could be an onerous and expensive responsibility.
Why defer payroll taxes instead of forgiving them altogether?
The President doesn’t have the constitutional authority to forgive lost tax revenue. That counts as “spending,” and only Congress can approve that.
President Trump has promised that if he’s reelected, he will work with Congress to forgive the deferred payroll taxes owed by workers. But that’s a big “if,” and since businesses are legally responsible for withholding payroll taxes, many may be reluctant to stop collecting money they will ultimately be responsible for.
If payroll taxes pay for entitlement programs, then what’s going to happen to Social Security?
That turns out to be a pretty complicated question! Check out our analysis of five possible scenarios.
ss1 Workers pay the Social Security tax until their annual earnings reach the “taxable maximum.” This means that in 2020 workers will pay the tax on earnings up to $137,000. In contrast, there is no limit on earnings subject to the Medicare payroll tax. Workers pay 1.45% on all earnings up to $200,000, after which they pay an additional tax of .09%.