Shaves $2.3 trillion off the budget.

Payroll taxes are levied on the earnings, primarily wages and salaries, of people who work for an employer and on the net earnings of people who are self-employed. Unlike the individual income tax, payroll taxes are not applied to other sources of income, such as interest, dividends, or capital gains. The individual income tax also includes many deductions, exemptions, and credits; by contrast, payroll taxes are generally more straightforward and have few, if any, adjustments. A payroll tax can be paid by an employer or an employee, or by both. Typically, payroll taxes are set at a single uniform rate.

In the United States, payroll taxes are used to finance social insurance programs and are the second-largest source of federal revenues after the individual income tax. The two largest sources of payroll tax revenues are Social Security payroll taxes and Medicare payroll taxes. Social Security payroll taxes are the primary source of financing for Old-Age and Survivors Insurance and Disability Insurance. Only earnings up to a statutory maximum are subject to Social Security taxes. (That maximum amount is $147,000 in calendar year 2022.) The Social Security tax rate is 12.4 percent of earnings: Employees have 6.2 percent of earnings deducted from their paychecks, and the remaining 6.2 percent is paid by their employers. Self-employed individuals generally pay 12.4 percent of their net self-employment income. The primary source of financing for Hospital Insurance (HI) benefits provided under Medicare Part A is HI payroll taxes. The basic Medicare payroll tax rate is 2.9 percent of earnings. For employees, 1.45 percent is deducted from their paychecks and 1.45 percent is paid by their employers. Self-employed individuals generally pay 2.9 percent of their net self-employment income. Unlike payroll taxes for Social Security, the 2.9 percent Medicare payroll tax is levied on all earnings, and no taxable maximum applies.

Option

This option consists of two alternatives. The first alternative would impose a new payroll tax of 1 percent on earnings. The second alternative would impose a new payroll tax of 2 percent on earnings. For both alternatives, the income subject to the tax would match that of the Medicare payroll tax, so there would be no taxable maximum. The new tax would be paid entirely by employees. Self-employed individuals would face the same tax rates as those who work for an employer.

This option would not make any changes to existing payroll taxes. Further, unlike existing payroll taxes, the taxes described in the option would not be tied to the financing of a specific social insurance program.

Effects on the Budget

If implemented, the first alternative—imposing a new payroll tax of 1 percent—would reduce the deficit by $1.1 trillion from 2023 through 2032, according to estimates by the staff of the Joint Committee on Taxation (JCT). JCT estimates that the second alternative—imposing a new payroll tax of 2 percent—would reduce the deficit by $2.3 trillion over the same period, roughly double the effect of the first alternative.

The higher payroll tax would create an incentive for employers and employees to seek to change the composition of compensation, shifting from taxable compensation, such as wages and salary, to forms of nontaxable compensation, such as employment-based health insurance. The estimates account for that behavioral response.