Payroll Taxes: Funding Social Security And Medicare

Payroll taxes are levied on employees and employers, and they are deducted from wages, tips, and salaries. These taxes are used to fund social insurance programs, including Social Security and Medicare, and are the second-largest source of revenue for the federal government. In 2022, payroll taxes made up 30% of total federal revenues. Payroll taxes also fund local infrastructure and other designated programs.

Social Security

The Federal Insurance Contributions Act (FICA) created the taxes directed to the Social Security program, and they are levied equally on employers and employees on all wages up to a certain level. In 2024, the Social Security tax is 6.2%, paid by both the employee and the employer, for a total of 12.4%. Income above $168,600 in 2024 is not taxed for Social Security. The tax rate was originally set in 1937 at 1% of taxable earnings and has increased gradually over time. The current rate was set in 1990, although it has been modified twice in response to economic downturns.

Funds paid to Social Security taxes go into two trust funds: the Old-Age and Survivors Insurance (OASI) Trust Fund, which pays retirement and survivor benefits, and the Disability Insurance Trust Fund, for disability benefits. The OASDI provides benefits to elderly and disabled workers, their spouses, and surviving spouses or dependents. In 2023, the maximum taxable earnings are $160,200, and employers and employees each contribute 6.2% of the workers' wages for a combined 12.4%Most economists believe that the employer portion of the tax is ultimately borne by employees in the form of lower net compensation.

Medicare

The Medicare tax, also known as the Medicare Hospital Insurance (HI) tax, is levied at a rate of 2.9% of wages (split evenly between employees and employers). There is no wage cap on the Medicare tax. However, for married filers with earnings over $250,000 and single filers with earnings over $200,000, there is an additional 0.9% tax, resulting in a total Medicare tax of 3.8% on this income.

The Medicare trust fund comprises two separate funds: the Hospital Insurance (HI) Trust Fund and the Supplementary Medical Insurance (SMI) Trust Fund. The HI Trust Fund is financed mainly through payroll taxes on earnings and income taxes on Social Security benefits. It covers inpatient hospital stays, skilled nursing facility care, hospice care, and some home health services. The SMI Trust Fund, on the other hand, finances two voluntary Medicare programs: Part B, which covers physician services and medical supplies, and Part D, the prescription drug program. This fund is primarily financed by general revenues and the premiums paid by enrollees.

In 2022, the HI Trust Fund had revenue of $387 billion and a balance of $178 billion. While payroll taxes are the chief revenue source for this fund, other sources include income from taxing Social Security benefits, interest payments on trust fund balances, premiums from voluntary enrollees, transfers from the general fund, and miscellaneous receipts. The SMI Trust Fund, on the other hand, relies mostly on contributions from the general fund and premiums from participants, with separate premiums for Parts B and D and higher premiums for higher-income beneficiaries.

The total Medicare costs have been rising steadily, increasing the financial burden on the system. Between 2000 and 2020, Medicare costs rose from just above 2% of GDP to 4%, and they are projected to reach 6% by 2047. This rise in costs is due to various factors, including the increasing number of Medicare beneficiaries, the decline in the birth rate, and the rapid increase in healthcare costs.

Unemployment Insurance

The state unemployment tax is used solely to pay benefits to eligible unemployed workers. These benefits are deposited into dedicated state accounts within the federal budget and can only be used for unemployment insurance payments. The federal tax covers the costs of administering the UI and job service programs in all states. It also pays for half of the cost of extended unemployment benefits during periods of high unemployment and provides a fund for states to borrow from if needed.

The Federal Unemployment Tax Act (FUTA) authorises the IRS to collect the federal employer tax. FUTA taxes are calculated by multiplying 6% by the employer's taxable wages, up to the first $7,000 paid to each employee in a calendar year. Employers who pay their state unemployment taxes on time receive an offset credit of up to 5.4%, resulting in a net FUTA tax rate of 0.6% or a maximum of $42 per employee per year.

State law determines individual state unemployment insurance tax rates, which vary across the country. Employers must adhere to specific requirements, such as paying wages totalling $1,500 or more in any quarter of a calendar year or having at least one employee during any day of a week for 20 weeks in a calendar year.

Local infrastructure

Road Maintenance and Transportation

A significant portion of payroll tax investments goes into maintaining and improving roads, bridges, railroads, airports, and ports. Well-maintained transportation infrastructure is crucial for commerce, facilitating the movement of goods and products between manufacturers and consumers. It also makes it easier for workers to commute to areas with more job opportunities, addressing pockets of higher unemployment.

First Responders and Public Safety

Payroll tax investments also contribute to funding first responders, including emergency services and law enforcement. These professionals play a critical role in ensuring the safety and security of communities.

Public Parks and Recreational Spaces

Investments in local infrastructure may also include the development and maintenance of public parks and recreational spaces. These areas provide communities with opportunities for leisure, social interaction, and physical activity, contributing to the overall quality of life for residents.

Water Treatment and Sewer Systems

Upgrading and maintaining water treatment and sewer systems are another essential aspect of local infrastructure. Ensuring access to clean water and proper waste management is crucial for public health and environmental sustainability.

Public Buildings and Schools

Investments in payroll taxes can also go towards constructing and maintaining public buildings, such as schools, libraries, and government offices. Well-designed and maintained schools offer enhanced educational opportunities and improve the overall learning experience for students.

Local Government Autonomy and Resilience

While federal funding plays a significant role in infrastructure development, local governments also need stable and predictable revenue streams to maintain and operate these projects over the long term. This includes exploring diverse revenue sources, such as taxes, fees, and creative partnerships, to ensure they have the necessary funds for ongoing maintenance and resilience against economic shocks and natural disasters.

Workers' compensation

To be eligible for workers' compensation, the injury must be accidental and arise out of and in the course of employment. Occupational diseases, such as illnesses caused by long-term exposure to hazardous substances, are also covered.

The benefits available through workers' compensation vary by state but typically include temporary and permanent disability benefits, medical and hospitalization benefits, vocational rehabilitation services, and death and funeral benefits.

In Maryland, workers' compensation benefits include temporary total disability, temporary partial disability, permanent total disability, permanent partial disability, medical/hospitalization, wage reimbursement, and vocational rehabilitation benefits. The benefits are determined by the state legislature and provided by insurance companies, who set premium rates based on the probabilities of injury in different occupations.

It is important to note that workers' compensation awards in Maryland are tax-free, and taxes are not involved in the workers' compensation system for claimants.

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