Why Your Paycheck is 2% Less

By Joseph Henchman

The questions are already rolling in: why did my pay drop?

Tax policy can be complex and overwhelming, and for most Americans it boils down to what they see on their paystub. Most Americans will see their pay drop by about 2 percent in 2013 due to the expiration of the payroll tax holiday as part of the fiscal cliff deal.

What is the payroll tax?

Appearing on many paystubs as FICA, Med-FICA, OASDI, Social Security, or Medicare, most Americans have 6.2 percent of their paychecks withheld to fund Social Security (payments to retired and disabled individuals) and another 1.45 percent withheld to fund Medicare (health care for the elderly), for a combined 7.65 percent. Employers also contribute an additional 7.65 percent. Together, these taxes raise nearly $1 trillion per year.

What was the payroll tax holiday?

The payroll tax holiday was enacted in 2011, which reduced the employee share of the Social Security payroll tax from 6.2 percent to 4.2 percent. The holiday was not renewed when it expired at the end of 2012.

The payroll tax holiday replaced the previous Making Work Pay tax credit, which itself was adopted in 2009. That credit refunded 6.2 percent of a taxpayer’s earnings up to $400 ($800 for a married couple), with the credit phased out for those earning over $75,000 ($150,000 for a married couple) and eliminated entirely for those earning over $95,000 ($190,000 for a married couple). Put succinctly, the credit refunded the Social Security tax paid on income up to $6,500 for all but high-income earners. The credit was also refundable, meaning that those with no tax liability could still receive the credit.

Why did the payroll tax holiday expire?

The payroll tax holiday proved popular with taxpayers but costly, reducing federal revenues by some $10 billion per month. U.S. payroll taxes also fund some of our largest entitlement programs, so reducing them potentially aggravated the long-term solvency of Social Security. Proponents of the holiday argued that it boosted spending; experts continue to debate the effect on the economy of such short-term stimulus proposals. Proponents also stated that the federal government would make up Social Security’s lost revenue, although the federal government has no budget surplus to do so. The holiday therefore meant larger federal government borrowing, at a time of record deficits.

Who is affected by the payroll tax holiday expiration?

All Americans who earn wage income pay payroll taxes. While the fiscal cliff deal debate focused on how much higher taxes on wealthy Americans would be, most Americans will see a tax increase because of the payroll tax holiday expiration.

What else was in the fiscal cliff deal?

See here: http://taxfoundation.org/blog/details-fiscal-cliff-tax-deal
How will my taxes change?
You can visit our Interactive Tax Calculator to see how the fiscal cliff deal affects your taxes: http://interactive.taxfoundation.org/taxcalc/#calculator
The Tax Foundation is a nonpartisan research organization that has monitored fiscal policy at the federal, state and local levels since 1937. To schedule an interview, please contact Richard Morrison, the Tax Foundation’s Manager of Communications, at [email protected].