A Tax Hike is Coming Soon for the 47% and the 53%

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Raising taxes 47%Mitt Romney thinks 47% of Americans don't pay taxes. Well, most of those 47% of Americans would beg to differ.

Fact is, a whole lot of folks who don't earn enough to owe federal "income" tax do pay something called "payroll" tax. Those taxes, which currently consume 13.3% of most Americans' wages, are levied under the Federal Insurance Contributions Act, or FICA -- as in, "Who the heck is FICA, and why is she taking so much of my money?"

And on Jan. 1, 2013, these taxes are set to jump -- sort of.

Tax Math

The way FICA taxes work is pretty widely known, but a refresher course probably can't hurt.

Payroll taxes basically come in two flavors: a 2.9% Medicare tax, paid half out of an employee's paycheck, with the other half matched by the employer. Employees pay 6.2% of their paycheck to the government in the form of Social Security taxes (up to a limit of $110,100). And employers match these contributions, too, for a combined SSA tax bite of 12.4%.

In an effort to cushion the blow of the Great Recession, though, Congress passed laws reducing the employee's payment toward Social Security by 2 percentage points, leaving most of us paying just 4.2% in SSA taxes (plus Medicare), instead of 6.2%. Self-employed persons, who have to cover both the employee and employer portions of the SSA tax, are paying 10.4% instead of 12.4%.

Now, a 2 percentage point tax cut may not sound like much. But consider that on a $50,000 salary (that was about the median U.S. household income in 2011, according to the Census Bureau), a two percentage point tax break from 6.2% to 4.2% is worth a cool $1,000. That's real money in consumers' pockets. And just two more months, that extra $83 a month going to evaporate. Come Jan. 1, the temporary cuts expire, and we revert to the old tax level.

But Wait! You Can't Raise Taxes in a Recession!

This poses a quandary for the politicians. Most economists agree that it's a bad idea to raise taxes in a recession -- or even a slow recovery, which is our current condition -- because this puts a damper on GDP growth. Take money out of consumers' pockets and consumers have less to spend on cars, LCD TVs, and trips to Disneyland. But now we're faced with a situation in which 163 million American workers, many of whom "don't pay taxes" (according to Romney), are going to get hit with a $1,000-a-year tax hike.

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What are we to make of that?

Politicians on both sides of the aisle are resorting to convenient dodges as they look for ways to justify what American families will have to perceive as a tax increase. On one hand, Republicans such as Mitt Romney don't seem to want to consider the payroll tax a "tax" at all -- because if it were a tax, then clearly, much more than 53% of the country is "paying federal taxes." Likewise, U.S. Rep. Kevin Brady (R-Texas) denounced the temporary cut in the payroll non-tax for "endangering Social Security" -- and argues in favor of raising it.

On the other hand, Sen. Mark Begich (D-Alaska), argues the tax cut was always supposed to be "a temporary thing." Rep. Richard Neal (D-Mass.) laments it never really "met expectations" in regard to boosting the economy. And President Barack Obama urges removing the cap on FICA collection, such that income in excess of the current $110,100 ceiling would also be subjected to the payroll tax.

What it all adds up to, in the words of Sen. Orrin Hatch (R-Utah) is "strong bipartisan support to let that tax provision expire."

A Distinction Without a Difference

Now, maybe the GOP politicians are right. Maybe cutting payroll taxes wasn't such a great idea. After all, it seems logical to say that if you don't collect taxes earmarked to pay for Social Security, that endangers the solvency of the retirement system.

But by the same token, doesn't the failure to collect enough taxes to pay for national defense endanger the solvency of the Pentagon? Doesn't a flat refusal to raise taxes so we have enough revenue to pay the rest of our bills endanger the nation's education system, its highways, NASA, and all of the other programs we spend $3.6 trillion on every year. Those mounting deficits count too.

The truth, of course, is that the payroll tax is a federal income tax. It's 15.3% (or 13.3%, for now) of your income that's being taken away and sent to Washington, spent on who-knows-what. So perhaps the best way to address our nation's ongoing deficit problem is to start by calling a tax a tax. End the artificial distinction between the income tax "on payroll" and the ... other income tax. Admit that, yes, Virginia, almost all Americans pay income tax. And no, we don't pay enough to cover all the spending. Then perhaps we can start figuring out how to fix the problems that causes.

Sad to say, Motley Fool contributor Rich Smith pays payroll tax, income tax, and a whole lot of other taxes, too. How about you?
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