When the 2008 recession hit, federal lawmakers took an interest in lowering the tax burden on ordinary workers. In theory, lower taxes meant more spending by consumers and, in turn, an improving economy. Instead of lowering income tax rates, however, Congress passed a law reducing payroll taxes that go into the Social Security trust fund. The tax cut was scheduled to expire at the end of 2012.
Payroll taxes appear as "FICA" (Federal Insurance Contributions Act) deductions on your paycheck. This means Social Security and Medicare taxes. Before the recession, workers paid 6.2 percent of their gross wages for Social Security tax. As the economy continued dragging into 2010, Congress reduced this to 4.2 percent. Medicare tax rates stayed the same, and the employer-paid portion of the tax remained at 6.2 percent. The reduction also benefited the self-employed, who pay both employee and employer portions.
Payroll Tax Cut Extensions
Congress extended the payroll tax cut in 2011 and 2012, keeping the rate at 4.2 percent for employees and 10.4 percent for the self-employed. In the meantime, the economy came out of the recession and returned to slow growth.
Return to Higher Payoll Tax
If Congress and the president allow payroll taxes to return to 6.2 percent for workers, that will mean less take-home pay after income tax withholding (which employees can adjust by filing a W-4 and claiming more allowances). But since payroll taxes are not deductible, there is no effect on the amount of income tax to be paid, as long as your net income remains the same and income tax rates don't change.
In theory, Social Security is a self-financed program, paid for by your FICA deductions. However, the federal government is borrowing this money every year to pay for its operations and deal with its own budget deficits. Social Security benefits are paid out of a dwindling trust fund piggy bank, to which the government writes an IOU in the form of U.S. Treasury bonds for the loans. This may well mean higher payroll and income tax rates in the future to pay benefits to an increasing number of Social Security retirees.
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