What are Payroll Taxes?
Payroll taxes are the statutory deductions made by the employer from an employee’s periodic salary and wages, and usually, such withholdings mostly have both employer and employee equal contributions. In the majority of the countries, these taxes are collected by tax authorities from respective employers and paid to the central government’s treasury for human welfare schemes, infrastructure development, etc.
The primary payroll taxes in the UK, USA are social security, national insurance/medicare, and self-employment income taxes.
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Components
Components are discussed below:
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#1 – Social Security Tax
Social security tax is deducted from an employee’s salary or wages, and the employer is also required to pay a social security tax, which means the employer is responsible for submitting to the government both the employee and the employer contribution of the social security tax. As a result, the social security tax is both an employee allowable deduction and an employer’s expense.
Social security taxes are levied at a fixed percentage up to a particular income limit only. These taxes take care of retirement benefits, disability, and various other citizen benefits in American and European countries.
#2 – National Insurance Tax
National insurance tax is also withheld from an employee’s salary or wages, and the employer is also required to pay a class 1 and class 2 national insurance payroll taxes. In other words, the employer is responsible for remitting to the government both the employee and the employer portions of the national insurance taxes. The employer can claim the deduction of these expenses in their tax returns and is an allowable expenditure for tax purposes. To understand about national insurance payroll deductions in the UK let’s understand an example;
Gemma works for black plc. She is paid £48,000 in 2018/19. We need to calculate gemma’s national insurance employee and employer contribution.
Employee’s Contribution:
- £(45,000-8,164)= £36,836 x 12% (main) = £4,420
- £(48,000-45,000)= £3,000 x 2% (additional)= £60
- Total Employee Contribution = £4,480
Employer’s Contribution:
- £(48,000-8,164)= £39,836 x 13.8% = £5,497
#3 – Regular Income Tax
These are the regular monthly tax withholdings from an employee’s salary or wages monthly as per the tax laws stipulated by the federal government. These are calculated at the start of the year and periodically deducted so that employees don’t feel the burden at year-end by paying the accumulated taxes and can also claim if paid in excess. While calculating these taxes, all deductions and allowances are taken care of as per the declaration by the employee at the start of the year. These ensure regular revenue to the government periodically and lesser tax evasion.
Advantages
Some of the advantages are as follows:
- They apply to all wages and salaries up to a capping of a certain amount where the majority of people’s income falls under. Also, unlike the personal income tax, payroll taxes do not include any deductions, exemptions, and credits that narrow the tax base. It means that these taxes can raise a large amount of revenue without major investment and hassles, which ultimately concludes that they are broad in nature.
- These taxes in most of the countries are collected at source from employee’s salaries regularly, considering the employee declaration of income and investments during the year. It eliminates unnecessary documentation at the time filling of employee returns and saves time for both the tax authorities and the assessee. Through this process, an employee can claim the excess payroll tax paid as a refund through his return to the government.
- They are very difficult to evade because all these deductions are made at source and upfront from an employee’s salary or wages at a fixed percentage and submitted to the federal government with proper record maintenance.
Problem Areas and Potential Resolutions
- PayrollPayrollPayroll refers to the overall compensation payable by any organization to its employees on a certain date for a specific period of services they have provided in the entity. This total net pay comprises salary, wages, bonus, commission, deduction, perquisites, and other benefits.read more taxes on employers such as social security contributions are regressive tax in natureRegressive Tax In NatureA regressive tax is the system of taxation where all citizens in the country are taxed at the same rate without considering their income levels. As a result, a more significant percentage of the income of the low-income group is charged as tax compared to the high-income group.read more which means the more income an individual earns the lesser percentage of payroll taxes he pays to the federal government because it gets levied only up to a fixed income capping limit at a fixed percentage as determined yearly by the federal government tax authorities. For example, an employee Anny making £75,000 annually in salary pays a fixed percent indirect employee-side social security payroll taxes, but an employee bunny making £300,000 annually in salary also pays the same percentage of contribution but only up to the fixed threshold of say £100,000, which means the overall payroll tax percentage as a proportion of total income is less than half in bunny’s case as compared to Anny’s case, even though employee bunny earns 4 times the income of employee Anny.
- There are alternatives to reduce this regressivity by removing the entire payroll tax capping would lead to a massive increase in additional government revenue over the next few years, and primarily impact high net worthNet WorthThe company's net worth can be calculated using two methods: the first is to subtract total liabilities from total assets, and the second is to add the company's share capital (both equity and preference) as well as reserves and surplus.read more individuals. Further, this additional revenue could be used to lower marginal income tax ratesMarginal Income Tax RatesA marginal tax rate is a progressive tax structure in which an individual's tax liability grows in proportion to the amount of income he earns over a course of a financial year. It ensures that all citizens are judged equally based on their income.read more on corporate and personal income.
- Structural reforms need to be inducted into payroll tax regime by introducing alternative taxes such as VATVATValue-added tax (VAT) refers to the charges imposed whenever there is an accretion to a product's usefulness or value throughout its supply chain, i.e., from its manufacturing to its final selling point. It is an indirect tax levied on the product consumption.read more to eliminate the progressive nature of taxes and do away with any kind of capping which we have in the current tax scenario. Also, simplified payroll tax deduction forms and rules need to be introduced in order to submit these taxes in a quick and simplified manner to the federal government.
Conclusion
Payroll Tax on employers does an excellent job when it comes to collecting handsome revenue for the federal government, which is the primary objective of any kind of taxes and eliminate fiscal deficitsFiscal DeficitsFiscal deficit refers to the situation where the total budget expenditure exceeds the total budget receipts, excluding the government borrowings in a given fiscal year. It determines the amount the government needs to borrow for meeting its excess expenditure.read more as well. It is regressive in most of the countries and applies at a fixed percentage up to a particular income capping. Still, this regressivity can be severely by introducing alternative taxes which doesn’t take into account any kind of income capping and provide a steady amount of revenue as well to the federal government.
However, as is the case with almost the complete tax system in all major countries, there is still some room for improvement.
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