April 06, 2018
Last month New York Governor Andrew Cuomo signed into effect a law that created an optional employer-side payroll tax as a partial substitute for the state income tax. Since then the word in many news outlets is that the take-up is likely to be low since the new tax is complicated.
This complexity line is especially being pushed by conservatives, as in this Newsday article, since the point of the tax is to develop a workaround for the limit on deductions for state and local income taxes (SALT) in the new tax bill the Republicans pushed through Congress last year. This bill limited the SALT deduction to $10,000. This limit was quite explicitly put in place to hit more liberal high tax states like New York and California. Their plan was that if these states wanted to provide higher quality services to their residents and a stronger social safety net, they would pay a big price for it.
The employer-side payroll tax is a way to preserve deductibility. The expectation is that an employer-side payroll tax will come out of wages. To take a simple case, suppose a worker gets paid $200,000 a year. If her employer goes the payroll tax route then the employer will be a paying a 5 percent tax, or $10,000, on the worker’s $200,000 salary. We would typically expect this to result in the worker seeing a pay cut of $10,000 so that she only earns $190,000.
While workers don’t like pay cuts, in this case, it should not be an issue, since the payroll tax saves them $10,000 on her state income taxes. This means she has just as much money with $190,000 annual pay as she did before when she got paid $200,000 but owed the state $10,000 in state income taxes.
The big difference is that she now faces federal income taxes on just $190,000 of income, not her former $200,000 income. Since this worker is in the 32 percent federal tax bracket, this shift saved her $3,200 off her income taxes (32 percent of $10,000). And contrary to what is implied in the Newsday piece, she gets this savings whether or not she itemizes on her tax return.
Now the question is, how complicated is this? My point of comparison is flexible savings accounts (FSA) that allow workers to set aside money from their paycheck for medical or childcare expenses, and not have this money subject to federal taxes.
To collect this money it is necessary to submit forms to the company that manages the account. Often the forms are rejected because more information is required, which means it is necessary to file the same claim twice or even three times. In addition, workers lose any money that is unspent at the end of the year, so if they put aside too much money in an FSA, they just threw it into the garbage.
The maximum amount someone can put into an FSA is $2,650. This means if the worker is the 25 percent income bracket, the most they can save on their income taxes is $662.50. Since they would also save the 7.65 percent on Social Security and Medicare taxes, the maximum savings for most workers would be $865.25, less than one-third as much as our $200,000 a year earner pockets from the employer-side payroll tax.
In spite of the limited potential savings, the complexity for the worker, and the risk of losing money at the end of the year, FSAs are very popular. (We even have them at CEPR, in spite of my objections.)
Now compare this to the complexity of the employer-side payroll tax. What does the worker have to do over the course of the year to get their tax savings?
That’s right: absolutely nothing.
How about the employer? Well, the employer has to do a one-time adjustment of withholdings, sort of like the one-time adjustment of withholdings that all employers had to do as a result of the change in the tax code. That really is not very complicated since the invention of spreadsheets. But in any case, it is a level of complexity that employers, or the payroll companies they use, have seen many times before.
So given that employer-side payroll taxes are much simpler than FSAs for employees, that there is far more money at stake, and the difficulty for employers is not especially large, why do we think few people will take advantage of this opportunity to skirt the limit on the SALT deduction?
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