Tax Increases Will More Than Cancel Your Base Pay Raise This Year, Ho Ho Ho!

Posted by Jason Van Steenwyk

describe the imageEveryone who has good plans to spend, save or invest your 1.7 percent increase in base pay taking effect this month, take one step forward.

Not so fast, soldier.

Yes, Congress approved a 1.7 percent increase in base pay this year. But the entire pay raise – and then some – is cancelled out by the expiration of the so-called “payroll tax holiday.” That’s going to result in a 2 percent increase in tax withholding, courtesy of your friendly local MILPERS office.

Here’s what happened.

What are payroll taxes, anyway?

The payroll tax, in a nutshell, is money your employer sends to the Social Security Administration, where it goes to fund old-age pensions and disability pensions under Social Security, and Medicare benefits for current beneficiaries. Any surpluses buy treasury bonds – that is, government debt. (The real answer: Congress spends every dime and replaces it with an IOU.)

Until 2010, the payroll tax for the Social Security portion of the tax was 12.4 percent. Of that amount, employers would kick in half and withhold half from employees’ paychecks as well. So both sides paid 6.2 percent each, up to a cap which was set at $110,100 per year in 2012, and $113,700 for 2013.  In addition, both employer and employee pay an additional 1.45 percent for Hospital Insurance, or Medicare. If you are an employee, that comes right out of your check before you even see it.

Self-employed people get to pay both halves of both taxes.

In late 2010, though, Congress was looking for ways to stimulate the economy, which was then mired in a nasty recession. So they looked for ways to boost consumer spending power. Among their solutions: Cut payroll taxes. Not for employers, but for employees. So Congress passed a law that cut payroll tax withholding from 6.2 to 4.2 percent of wages. That is, a 2 percent cut.

All other things being equal, paychecks – military paychecks included – went up by 2 percent of total wages.

Originally, the measure was only supposed to last a year. But Congress renewed it to keep juicing the economy. Until this year. The latest tax deal that ostensibly avoids the fiscal cliff does not renew the payroll tax holiday. Wage earner taxes are going up.

And you thought only millionaires and billionaires were going to be affected.

Why not extend it?

Why not simply extend the payroll tax cut indefinitely? Because there is a price to be paid for the lower tax level: The taxes go to pay current Social Security benefits. If the payroll tax holiday continued, the reduced revenue coming into the program would start eating into Social Security benefits. Seniors are, of course, a powerful lobby. And they themselves paid into the system their entire working lives, expecting to receive their full benefit. If payroll taxes are too low, Congress would either have to lower benefits, raise the retirement age, or raise revenue somewhere else in order to pay benefits. Continuing this payroll tax was undercutting the actuarial basis for maintaining Social Security. As the baby boomers reach retirement age, the strain on the Social Security System, combined with lower revenues from payroll tax withholding coming in, would push Social Security to the breaking point.

As it stands now, those days are over. So you’ll get your 1.7 percent increase in base pay. But you’ll also see withholding increase by even more than that. So military members will not see an increase in take home base pay. Instead, base pay will decrease by 0.3 percent, all other things being equal.

Happy New Year!

 


One response to “Tax Increases Will More Than Cancel Your Base Pay Raise This Year, Ho Ho Ho!”

  1. John says:

    Great article. Nice easy to understand language. Being a military tax preparer expert I’ll add one item. If you are active duty, from and have received combat pay in the past three years check out M-99 Credit for Military Service in Combat Zone http://www.revenue.state.mn.us/individuals/individ_income/Pages/Credit_for_Military_Service_in_a_Combat_Zone.aspx 
    Would be happy to answer any follow up questions.