Every (Legal) Worker in America Pays Tax on Their Income

I just have to get this off of my chest. There is a meme that is going around – particularly in the conservative press and from the lips of wealthy people being interviewed – that there are a large portion of workers in America who do not pay taxes on their income. The example of this misinformation that initiated this post is the following quote in a Wall Street Journal interview with Fred Smith, the CEO of FedEx, a man whose received $8.64 million in compensation last year.

He sees a big problem in that so few Americans now pay any income tax. “We’re now at a point where a very large part of the population pays no federal income tax at all. When you have a majority of the population that realizes that you can transfer money from the productive to themselves, that’s one of the great questions for the future of civilization, as far as I’m concerned.”

In many cases, the meme is associated with the concept of a tax cut for 95% of the workers in the US, with people on the right asking how that can be since there are so many who do not pay “income taxes”.

The problem with this meme is that it is only true if the words are carefully selected so that “income tax” is not defined as “taxes on income” but as the taxes paid into the IRS on a 1040 or a 1040A. As a former general manager at a very small company with low wage workers and as a former self-employed person with a tiny income during the start-up phase, I can tell you that every legal worker in America begins paying taxes on wages with the very first dollar that comes in.

The tax is called FICA, which stands for a carefully named program called the Federal Insurance Contribution Act. It is designed so that it looks like it is only 7.65% for most workers, but the real rate is 15.3%. Half of the tax does not even show up on the payroll stub – unless you happen to be self-employed. People like Mr. Smith might forget about that tax because it disappears into insignificance – a person who receives $8.64 million in compensation would pay a maximum of $12,090 plus 2.9% of salary. Most of the FICA line disappears from Mr. Smith’s payroll stub by January 5th each year.

I would have run the numbers on that 2.9% but then remembered that the 2.9% rate is only applied to salary, not to stock options, private plane allowances, perks, bonuses, or other components of executive compensation. (My numbers include the “employer’s” share, because I assume that most of the perceptive readers on this blog can see through the farce and realize that any tax on the earnings of an employee affects the take home pay for that employee.)

The reality of the pain of these “payroll taxes” hit me pretty hard when I was in my poverty phase. I never really thought to much about them when I was young and working for spending money – my parents took care of the basics like food, clothing, and shelter. Unlike Mr. Smith, my parents were not rich, but they were comfortably situated in the middle class.

I started to realize how important FICA taxes were to people struggling at the bottom of the income scale when I was there myself as a new entrepreneur, but even then, my family had a nice home, full closets, and plenty to eat because of personal savings and family provided investments in my endeavor. (I made the entrepreneurial choice after about 12.5 years of working in a reasonably well compensated position.)

The FICA hit really hit home when I was working as the GM for J&M Industries, one of those little companies that form the backbone of the American economy. We employed between 15 and 25 workers in a plastic injection molding company. Most of the employees were production workers. They could be trained for entry level positions in just a couple of hours as long as they could handle basic math, were willing to work hard at repetitive tasks, and could be counted on to show up on time. Our wage scale was not great, but it was a bit higher than fast food.

I clearly remember the day that a couple named Dale and Sharron came into the office and asked for a job. They had met one of our employees and heard that we were ramping up production for a large contract with Tupperware. We talked for a time, they showed me what they could do, and started work the next day. Both of them were very slender – almost skinny. After the second day on the job, Sharron shyly approached me and asked if there was any way they could get an advance on their pay. After a couple of questions, I found out that they had not had anything to eat that day because they did not have any money at all. They told me all they needed was $10 for some rice, beans and eggs and that would last them until payday – 3 more days away.

When I produced the paychecks for these two people at the end of the week, I could not help but notice that the total FICA tax on their combined week’s paycheck was about 6 times more than what they had asked to borrow for 3 days worth of food.

I know that FICA has been sold as a “contribution” for insurance that covers Social Security and Medicare. However, I also know that the federal government has been using the surpluses in the Social Security accounts for a couple of decades to cover the operational costs of its current spending programs rather than being honest with the citizens about how much their demands are costing. I also am intimately familiar with where a good portion of those dollars go. Contrary to popular belief, it is not into the pockets of people like Dale and Sharron, it is into the pockets of people like Mr. Smith, whose company probably sells at least a billion dollars a year in services directly to the federal government, whose planes fly into airports subsidized by taxpayer funds, and whose trucks ride on government purchased roads and bridges. His Social Security income will greatly exceed theirs, even though he will probably not even notice its contribution to his lifestyle.

I am pretty sure that Sharron, a very hard working and productive employee, never collected a dime from her Social Security contributions. I lost track of her after she found out that she had stage 4 cancer. That part of the story is rather fuzzy in my memory, but I also seem to recall that Medicare was not going to pick up any of the proposed treatment costs. J&M Industries did not provide health care insurance; our pool of workers was not very attractive to the insurance companies.

Please forgive the serious detour from discussions about energy, but sometimes I have to express my thoughts about other topics.