Payroll tax is a form of tax that is normally inflicted on employees and employers, which is calculated as a percentage of the salaries employees pay their staff (Thomas 203). According to Thomas, payroll taxes regularly fall into two categories: deductions made directly from an employee’s wages and secondly, the taxes paid by an employer depending on the employees’ wages (203).
The first form of tax deduction is where an employer is required by the state to withhold a fraction of the employees’ wages, often covering social security contributions, advance payment of income tax as well as various insurances needs like unemployment and disability. The second tax form is tax remunerated from the funds of the employers, often directly connected to hiring a worker. These funds often wrap the employers funding of the social system, together with other insurance programs. This paper will look into the basics of payroll tax in the United States, with elaborations on the two forms of payroll tax deductions (Piketty 212).
- Wage Withholding
All the employers are required to deduct taxes from an employee’s pay, and dispatch the taxes withheld to the government on behalf of the employee, as payment of tax (Reid 77). After all this is done, the employee then claims a credit for withdrawn sum of tax, resulting from the actual tax liability calculated when filing a return (Reid 77). Every employer is required to withhold three classes of taxes: federal income tax, Medicare tax, Social Security tax, and local and state taxes from the earnings of each employee under their turf. This wage withholding is sometimes referred to as Pay As You Go (PAYG) or Pay as You Earn (PAYE).
- Social Security withholding
This form of taxation is normally withheld at an even rate of 6.2% on the gross wages of an employee, after deducting any pre-tax subtractions (Piketty 87). In the U.S, communal security is principally the Old-Age, Survivors, and Disability Insurance (OASDI). The history of this form of taxation dates back to the 1930s, when Franklin Roosevelt commenced and implemented this tax on his first term throughout the great dejection of the twentieth century. This period was characterized by severe poverty, with over 50% of the elderly people living beneath the poverty line. This was done to curb the unforeseen hazards in the contemporary life, which include disability, old age, unemployment, poverty and ease the burden on widows and widowers with children (Reid 67).
Since inception, the rations of societal protection have changed to conform to the rapid changes in the economic landscape as well as protection for the underprivileged, disabled, dependent children and survivors. The funds collected are forwarded to the programs that cater for the less privileged in the society, like OASDI, Medicare and Supplementary Security Income (SSI). These are the bodies that ensure there is repayment of benefits in terms of retirement benefits. These are benefits that see to it that lower paid workers do not retire to absolute poverty. In the United States, every worker has a societal Security identification number for the benefits discussed.
- Medicare Taxes
Medicare is a form of societal indemnity program here in the United States. It is governed the United States Federal government, and currently has over thirty insurance companies under its roof. Medicare makes sure that there is access to quality health insurance to people with disabilities, old people as well as people with terminal illnesses. As a social indemnity program, Medicare spreads the risks across the society. The program was initiated in 1965, under the watchful eye of President Johnson, to provide health insurance to the elderly, regardless of the medical or income history.
As elaborated by Reid, Medicare is normally administered by Medicaid, SCHIP, Clinical Laboratory Improvement Amendments (CLIA) and Department of Health and Human Services (HHS) (99). These bodies are those that are necessary for the collection of Medicare taxes, determining eligibility and payment of the low income subsidies. The benefits consist of medical and hospital covers, Medicare Assistance and Prescription drug plans. The beneficiaries are determined by these bodies governing the collection and disbursement of the Medicare taxes (Reid, 56).
- State Income Tax
Most of the individual states all over the world amass State Income Tax, in concert with the federal income tax. The rates diverge from state to state, at a preset or graduated rate taxable on an individual’s income as well as corporations. Taxes are also collected from the incomes of non-residents working within the state. Most states that impose individual income tax on people also allow most business deductions in the form of depreciation of business assets (Reid 142).
Corporate Income Tax
Most states inflict a tax on corporations with a enough link with the state, better known as “Nexus. Most states in the US impose a flat rate taxation rate, which clearly states the minimum amount of tax expected from every corporation. This normally holds because these corporations are normally presumed to have a considerable amount of connection (Nexus) between them and the state activities (Piketty 203).
It has been in existence in the United States for over a hundred years, at a fairly high rate of 35% of the gross income realized by the corporation, with UK corporate tax standing at just 21%. This has pushed many companied in the United States to relocate to other states, some selling stakes to companies offshore to pay less tax (Inversion) (Reid 117). This has negatively affected manufacturing in the United States, leading to a decline in manufacturing and damaging the economy in terms of unemployment and revenue reduction. However, most companies pay less due to exemptions, loopholes and tax credits.
Many states use a three formula factor to tax businesses and corporations within their jurisdiction. Some States within the US use all these factors in taxing corporations, while some utilize only one factor in the formula, for example taxing on the basis of revenue (Reid 212).
- Non-Business Income
Some states tax corporations within their jurisdiction on the basis of non-income revenue, regardless of the degree of apportionment. Non-business income is that which include the outlay incomes of the business corporations, which include dividends (Reid 222).
- Consolidated filings
Some states require that controlled groups of corporations should file their returns on a combined basis. In specific, some states like Illinois and California require that all unitary corporations must file their returns in a consolidated basis.
Payroll Taxation in different countries
As explained by Reid, in the United Kingdom, PAYE is necessitated on the payment of all salaries and wages, as well as other compensations (Piketty 217). The amount is determined by the National Insurance Category and the tax code determined by HM Revenue and Customs (HMRC). This is based on an employee’s projected tax exemptions, allowances and reliefs for the whole taxable year. PAYE applies to sick leave pay, maternity pay, pensions and directors’ fees in the UK.
In Ireland, PAYE embraces deductions of the Pay Related Social Insurance (PRSI) and earnings tax. The amount is reached at by the employers on the basis of a Standard rate (certificate) and Certificate of Tax Credits, availed by the Ireland Revenue Authority (IRA). As for New Zealand, PAYE is deducted from the salaries or wages of the employees’, and paid to the Ireland Revenue Department (IRD) (Reid 179). This includes AAC and income tax which is calculated on the tax codes provided by the employee as well as the tables provided by the IRD (Reid 163).
In the above instances, it is clear that these three countries use different approaches to payroll taxation, despite the fact that they all serve a common purpose. In other countries, the approach to payroll taxation is quite similar, despite the disparities in geographical positioning. In Australia, the PAYG tax withholding system is administered (Reid 179). The employers calculate the amount of income tax on the basis of tables provided by the Australian Tax Office (ATO), depending on employee declaration (Piketty 145). The same applies for Canada, which needs deduction at the source for payments by employers.
The deductions are required for employment insurance, pension plan contributions, and provisional income taxes (Reid 145). In most parts of Europe, European member countries impose the PAYE on wage payments, apart from France. The same case applies to many other countries like the United States and Morocco, with similarities in the payroll tax deductions in countries in Africa (Piketty 209). The modes of collections are different, but the pooled funds are used to insure the future lives of the beneficiaries against harsh economic and social predicaments.
Piketty, Thomas, and Emmanuel Saez. How Progressive Is the U.S. Federal Tax System? A Historical and International Perspective. Vol. 5. Cambridge, Mass.: National Bureau of Economic Research, 2006. 88-217. Print.
Reid, Gayla, and Tim Enders. Paying Taxes. Vancouver: People’s Law School, 2011. Print.