Social Security and Payroll Taxes

What does the payroll tax have to do with Social Security?  With the recent presidential executive order calling for deferral of payroll taxes for the rest of 2020, it’s worth looking at what that means for workers now and for Social Security in the future.  Many people planning for retirement or already retired ask me if they should worry about Social Security retirement benefits being cut.  Payroll taxes are part of the answer.

What is the Payroll Tax?

Payroll taxes are comprised of a few pieces.  Workers on a “payroll” have 6.2% of their earnings (up to $137,000) deducted and sent to the federal government’s Social Security trust funds (one for old age and survivors – OASI – and one for disability) .  I’d like to imagine those funds being set aside and growing steadily for each of us to receive in our retirement years.  But that would be silly.  This part of the payroll tax is mostly used to pay Social Security benefits to current recipients.

The second part is 1.45% deducted from paychecks and directed into the Medicare trust funds (one for hospital insurance and one for supplemental medical insurance covering physician visits and prescriptions).  This piece is also not held for us to use one day; it subsidizes the costs of providing Medicare coverage to current participants.

Lastly, employers kick in a matching amount so that the total going to the federal government is 15.3% of workers’ pay.  You self-employed people should recognize that amount.  It is what you pay in “self-employment tax” each year.  You have no employer to match your “contribution” so you are left to fund both amounts.

How does this relate to Social Security?

Since payroll taxes are funding benefits for current recipients of Social Security, money has to be there to make those monthly payments.

According to the annual report of the Social Security Board of Trustees issued in April 2020, this year  is projected to be the last in which income from payroll taxes will be larger than outflow to beneficiaries (by just $2 billion).  However, that was without considering the impact of the pandemic economic shutdown.  Paying beneficiaries, from now on, will require the trust fund to be spent down. At the beginning of the year it held $2.897 trillion.  How long will that last at the projected rates of income and outflow?  Currently, the Social Security Board projects that the OASDI trust fund can pay all promised benefits through 2035.  After that, it is projected that payroll tax income would only support 79% of benefits to be paid out.

Is a Payroll Tax deferral a good idea?

It depends.  As a tool to promote economic recovery, it has been used before.  The Social Security portion of payroll taxes paid by employees was reduced 2% (from 6.2% to 4.2%) in 2011 and 2012 to help with the recovery from the great recession.  In 1977, the New Jobs Tax Credit was enacted to provide a tax credit of 4 percent of Social Security payroll taxes paid by employers.  The idea was to give a tax incentive to employers to hire more workers in a time of high unemployment.

If lowering the cost of hiring workers and creating new jobs is the goal, then an employer-side payroll tax reduction or holiday could be a good strategy.  If the goal is to put more money in the pockets of workers to spend and drive economic activity, then an employee-side payroll tax holiday can be effective.  A payroll tax deferral, that is to be paid back later by businesses or workers, would seem to have an uncertain or temporary impact.

However, in the long run, payroll tax reductions or holidays deprive the Social Security trust funds of much needed income.  Without a plan to address this, the date of reckoning for the Social Security system will draw even closer.

Sources: Social Security Administration (, The Tax Foundation (

You may also like:  Tax Myths and Truths

Any opinions are those of David Werle and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notices.

Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Prior to making an investment decision, please consult with your financial advisor about your individual situation. You should discuss any tax or legal matters with the appropriate professional.