How Much Federal Tax Does A Service Industry Pay?

Cardinal Findings

Boilerplate workers in the United States face two major taxes on wage income: the individual income tax and the payroll tax (levied on both the employee and the employer).
Although slightly more than than half of a U.S. worker's payroll tax burden is paid by their employer, the worker ultimately pays this taxation through lower take-home pay. Before accounting for state and local sales taxes, the U.Due south. tax wedge—the tax brunt that a single average wage earner faces—was 29.8 percent of pretax earnings in 2019, adding upwardly to $eighteen,368 in taxes.
The U.Southward. tax wedge of 29.8 percentage has consistently been below the OECD average, which was 36 percent in 2019.
The U.Southward. tax wedge rose by 0.2 percentage points in 2019, merely remains about 2 percentage points lower than prior to the Tax Cuts and Jobs Act (TCJA) that reduced most individual income tax rates.

Introduction

Individual income taxes and payroll taxes make up a large share of revenue enhancement acquirement in the United States and together comprise the tax burden on labor. The U.S. tax lawmaking is progressive, combining a highly progressive individual income revenue enhancement with a more than regressive payroll tax.[1] While the U.Southward. code is progressive, the average worker is burdened by taxes. Due to provisions in the tax code that benefit families, the revenue enhancement burden on families is often lower than the burden on single, childless workers earning an equivalent pretax income.

The Organisation for Economical Co-operation and Development (OECD) produces an annual study on the taxation burden on labor in the U.S. and 35 other developed countries.[two] OECD data shows that single childless workers earning an average wage in the U.S. faced a tax burden from income and payroll taxes of 29.8 percent in 2019, upwardly 0.2 percentage points from 2018's charge per unit of 29.six percent.

The tax burden on labor in the U.S. remains lower than prior to the Tax Cuts and Jobs Act (TCJA), which reduced private income tax rates beginning in 2018, reducing the tax brunt on labor. The tax wedge in 2019 was 2 percentage points lower than in 2017, when single childless workers faced a revenue enhancement wedge of 31.8 percentage.

Subsequently accounting for sales taxes, which reduce the purchasing power of earnings, the revenue enhancement wedge in the United States in 2019 was 31.half-dozen percent.

Considering there is a negative human relationship between the tax wedge and employment, policymakers in the U.S. and other OECD countries should explore ways of making the revenue enhancement of labor less burdensome to amend labor marketplace efficiency.[3] This will be important equally policymakers pursue a strong labor market and economic recovery in the U.S. when the coronavirus outbreak subsides.[4]

Tax of Wage Income in the United States

There are 2 major types of taxes that workers in the U.S. pay on wage income. Beginning, individual income taxes are levied by federal, most state, and sometimes local governments to fund government services. Second, the federal authorities levies payroll taxes on both employees and employers. The economic burden, or incidence, of employer payroll taxes ultimately falls on wage earners. Payroll taxes fund federal programs such as Social Security, Medicare, and Unemployment Insurance (UI).

The tax wedge on labor income is the difference betwixt total labor costs to the employer and the cyberspace take-home pay of the employee. To calculate a country's tax wedge, the OECD adds the income revenue enhancement payment, employee payroll tax payment, and employer-side payroll taxation payment of a worker making the country's average wage. The OECD divides this amount by the total labor cost of this boilerplate worker, or what the worker would have earned in the absenteeism of these three taxes.

The United States' tax wedge is the combined labor tax brunt, which comprises the income taxation, employee-side payroll tax, and employer-side payroll tax, divided by the total labor cost of the average worker (what the worker would take earned without the taxes). Dissimilar the tax wedge in many OECD countries, the U.South. revenue enhancement wedge does not include a value-added tax (VAT) on consumption. Nonetheless, the U.S. levies sales taxes on consumption at the state level (see below).

The Individual Income Tax

The federal individual income revenue enhancement is the largest component of the tax burden on labor. In the Usa, federal income taxes are graduated, significant they are levied through a series of marginal tax brackets at progressive rates.[five] Beginning in tax year 2018, the TCJA lowered virtually individual income tax rates through revenue enhancement year 2025. Each year, the Internal Revenue Service (IRS) increases the wage threshold of each subclass for aggrandizement, meaning the individual income taxation is indexed to inflation.

Table 1. 2020 U.S. Individual Income Tax Brackets and Rates
Tax Rate	For Unmarried Individuals, Taxable Income Betwixt	For Married Individuals Filing Articulation Returns, Taxable Income Between	For Heads of Households, Taxable Income Between
>10%	>$0 – $ix,874	>$0 – $19,749	>$0 – $14,099
>12%	>$9,875 – $40,124	>$xix,750 – $fourscore,249	>$14,100 – $53,699
>22%	>$forty,125 – $85,524	>$80,250 – $171,049	>$53,700 – $85,499
>24%	>$85,525 – $163,299	>$171,050 – $326,599	>$85,500 – $163,299
>32%	>$163,300 – $207,349	>$326,600 – $414,699	>$163,300 – $207,349
>35%	>$207,350 – $518,399	>$414,700 – $622.049	>$207.350 – $518,399
>37%	>$518,400 and upwardly	>$622,050 and up	>$518,400 and up
Source: Internal Revenue Service; Tax Foundation, "2020 Tax Brackets."

Payroll Taxes

The United States levies three major taxes on payroll. The beginning is a 12.4 percentage tax used to fund Social Security, known as the old age, survivors, and disability insurance (OASDI) tax. This revenue enhancement is levied start on the starting time dollar an individual earns in wages and self-employment income upward to a cap of $137,700 in 2020. This cap is indexed to wage growth and typically rises each twelvemonth. Legally, the tax is paid half by employers and half past employees, although employees bear the full economic cost of the tax.

The second tax is a ii.9 per centum payroll tax to fund Medicare, known as the Medicare hospital insurance (HI) tax. This tax is also levied at the offset dollar of wage and cocky-employment income but has no cap. Every bit with the Social Security payroll tax, this tax is split evenly between employers and employees. An boosted 0.9 percent Medicare payroll taxation applies to earned income over $200,000 (this cap is not adapted for inflation).[6]

Table 2. 2020 U.S. Federal Payroll Taxes
	Social Security (OASDI) Tax		Medicare Hospital Insurance (Hullo) Tax
Taxable Earnings	Employee	Employer	Employee	Employer	Full
$0-$137,700	6.20%	half-dozen.20%	1.45%	ane.45%	15.3%
$137,700 – $200,000	0	0	ane.45%	1.45%	2.ix%
$200,00 and over	0	0	two.35%	1.45%	three.8%
Source: Social Security Administration, "OASDI and SSI Programme Rates & Limits, 2020."

In addition to the employer-side taxes that fund Social Security and Medicare, in that location is a third payroll tax that funds Unemployment Insurance (UI). Unemployment Insurance is a joint federal-state social insurance programme which insures workers against an unexpected loss of income if they lose their jobs. This revenue enhancement is levied on the employer.

The federal unemployment taxation is 6 per centum on the outset $7,000 of payroll, known every bit the taxable wage base.[7] All the same, states besides set UI tax rates to fund their portion of the plan. State UI tax rates and bases can vary widely, depending on how often an private employer's workers receive unemployment benefits (determined via an employer's experience rating). If an employer is probable to hire and burn her employees at a higher than normal rate, the employer volition face a higher revenue enhancement charge per unit. However, the federal and state tax rates are not additive. Employers can credit 90 percent of their state taxation against the federal tax, reducing the federal rate to as low as 0.vi percent.

Although payroll taxes are typically carve up betwixt workers and their employers, economists by and large agree that the burden of both sides of the payroll taxation falls on workers. In tax policy, at that place is an of import stardom between the legal and the economic incidence of a tax. The legal incidence of a tax falls on the political party that is legally required to write the bank check to the taxation collector.

However, the party who legally pays a tax is not e'er the one who ultimately bears the burden of the tax. The economic incidence of a taxation falls on a wider group of people and is determined by how people and businesses respond to a tax, with the less responsive parties more than likely to bear the economic burden of the tax.[8]

U.S. Revenue enhancement Burden on Labor for Unmarried Workers with No Children

In 2019, the United States' tax wedge for a single worker with no children was 29.8 percentage, beneath the OECD average of 36 per centum. Put some other way, a worker in the United States in 2019, making an boilerplate wage of $61,723 annually, kept 70.2 percent of that income, or $43,356.

Income taxes made upwardly the largest office of the tax wedge at fifteen.1 percent, or, on average, $9,335—slightly above the OECD average of thirteen.eight pct, as many other countries have higher payroll taxes on employers rather than direct income taxes. In full, the boilerplate U.S. tax wedge was $18,368.

US Tax Burden on Labor for Single Workers with No Children, In 2019, the United States' tax wedge for a single worker with no children was 29.8 percent, below the OECD average of 36 percent. Put another way, a worker in the United States in 2019, making an average wage of $61,723 annually, kept 70.2 percent of that income, or $43,356.

U.S. Revenue enhancement Wedge Holds Steady Two Years later on Tax Reform

The U.S. tax wedge rose slightly, by 0.2 percentage points, from 2018 to 2019: 29.6 percent to 29.eight percent. The tax wedge remains two per centum points lower than pre-TCJA, when it was 31.eight per centum in 2017.

The OECD average fell slightly, from 36.1 per centum in 2018 to 36 per centum in 2019. The U.S. revenue enhancement wedge has remained below the OECD boilerplate since 2000, and the gap widened after revenue enhancement reform in 2017, which reduced individual income tax rates and doubled the standard deduction. Lower taxes upshot in a higher net take-home pay, and therefore a smaller taxation wedge.

Family Composition and the Tax Burden

Similar many OECD countries, the U.South. provides targeted tax relief to families with children. This relief includes refundable tax credits such as the Child Revenue enhancement Credit (CTC) and additional credits for low-income families with children through the Earned Income Tax Credit (EITC).[9]

The average tax wedge for families in the U.S. was 18.viii percent in 2019, compared to the 29.8 percentage average tax wedge for unmarried workers with no children. The OECD average tax wedge for families is 26.4 percent, compared to the 36 per centum average tax wedge for single workers. These ii tax wedges, unmarried and family unit, are based on the aforementioned pretax wages (referred to as labor toll) because a "family" refers to a 2-child family unit with just one income earner.

Average and Marginal Taxation Wedges

Comparing the tax wedge for the average worker in the U.Southward. to the tax wedge for average workers in other OECD countries is only a fractional representation of how taxes on labor affect the economy by changing incentives to work and by raising revenue for regime at the federal, state, provincial, or local levels.

The OECD calculates two types of tax wedge: average and marginal. The average tax wedge is what has been discussed and so far: the combined share of labor and payroll taxes relative to total labor costs, or the tax burden. The marginal revenue enhancement wedge, by dissimilarity, is the share of labor and payroll taxes applied to the side by side dollar earned and tin can influence individuals' decisions to work.

The marginal tax wedge is by and large higher than the boilerplate tax wedge due to the progressivity of taxes on labor—as workers earn more, they face up a higher tax wedge on their marginal dollar of earnings. The marginal tax wedge in the U.Due south. is 38.5 percent, compared to an average tax wedge of 29.8 pct. Targeted tax relief for families with children helps lower the taxation burden on labor, just likewise increases the marginal taxation rate on labor equally the relief phases out when families earn additional income.[10] This creates a disincentive for families with children to earn boosted labor income equally this relief phases out.

Directly comparing marginal tax wedges across countries is less informative. Many countries' marginal tax wedges are higher than others simply because their overall taxation burden is loftier. One way to examine the efficiency of labor taxation in a land is to command for the level of labor taxation by taking the ratio of the marginal tax wedge to the boilerplate tax wedge. The ratio of the marginal tax wedge to the boilerplate taxation wedge for a country is a crude proxy for the economical toll of a government funding $1 more than of acquirement through taxes on labor, at whatsoever given level of labor taxation.

In the U.South., the ratio of the marginal taxation wedge to the average tax wedge is $1.24—in other words, $i.24 is the cost in the U.S. of raising an additional dollar in revenue from taxes on the workforce. This matches the OECD average ratio.

Bookkeeping for Consumption Taxes

The tax burden on labor is broader than personal income taxes and payroll taxes. Many countries also impose a VAT on consumption. Considering a VAT diminishes the purchasing power of individual earnings, a more complete picture show of the tax burden should include the VAT. Although the U.S. does not accept a VAT, land sales taxes diminish the value of earnings.

Accounting for country sales taxes, the U.S. tax wedge is 31.vi percent, slightly above the 29.viii percent tax wedge without state sales taxes. The OECD average VAT-inclusive tax wedge is 41.five per centum, compared to a VAT-exclusive revenue enhancement wedge of 36.0 pct. The U.S. has a relatively pocket-sized difference between the 2 measurements—i.viii percentage points—compared to the OECD boilerplate difference of five.v percentage points, because land sales taxes equally a share of total labor costs are generally much lower than VAT rates in other OECD countries.

Tax Brunt in the U.South past Employment Form

The tax burden on labor in the U.S. varies by form of employment in addition to income level, filing status, and number of children. In the United States, workers may be classified as employees or as independent contractors who contract with specific firms. Alternatively, workers may set sole proprietorships or similar "pass-through" businesses as a form of self-employment.

The tax wedge on employees and sole proprietors in the United States is 31.8 percent. Employees and sole proprietors remit individual income taxes and payroll (or self-employment) taxes on earned income.[11] The payment wedge, which includes non-taxation compulsory payments, is slightly higher for the U.Southward. employees at 32.seven percent, as employers besides pay workers compensation on behalf of employees at the land level.[12]

It is important to annotation that while the employee and sole proprietor tax wedges are equal, many self-employed workers (such as gig economy workers) face unique challenges in complying with the revenue enhancement lawmaking and remitting self-employment taxation.[thirteen]

Conclusion

Although the U.S. has a progressive tax system and a relatively depression tax burden compared to the OECD average, average-wage workers nevertheless pay about 30 percent of their wages in taxes. Individual income taxes and payroll taxes together make up the tax brunt on labor in the U.Southward., which increased slightly in 2019 merely remains beneath the levels faced by workers prior to the TCJA.

To make the tax of labor more efficient, policymakers in the U.Due south. and abroad should understand how the tax wedge is generated, and taxpayers should understand how their tax brunt funds authorities services. This will be particularly important as policymakers explore way to encourage a robust economic recovery later on the coronavirus crisis abates.

Methodology

Ratio of Marginal to Average Tax Wedge

The ratio of marginal to average tax wedges is calculated using the OECD information of marginal and boilerplate total taxation wedges at four levels of income for single individuals without dependents. Information technology is the average of marginal total tax wedges at 67 percent, 100 percent, 133 per centum, and 167 percentage of boilerplate earnings divided by the average of average full tax wedges at 67 percent, 100 pct, 133 percent, and 167 percent of average earnings.

Tax Wedges Bookkeeping for VAT

The formula for calculating taxation wedges that business relationship for VAT utilizes the VAT rates and the VAT revenue ratio (VRR) from the OECD's "What drives consumption tax revenues?" tax working paper.^[14] ^,[15] We outset summate the tax-inclusive VAT rate, which is VAT charge per unit/(ane + VAT rate). Next, we multiply the tax-inclusive VAT charge per unit past the VAT revenue ratio and past the total labor cost to summate the VAT amount. The formula for calculating the tax wedge including the VAT is so:

$Income Taxes + Employer and Employee Payroll Taxes + VAT/Sales Taxes) \ (Total Labor Cost + VAT/Sales Taxes)$

VAT/sales taxes are in both the numerator and the denominator considering the taxation wedge is taxes on labor equally a share of total labor costs. For employees, VAT/sales taxes are role of taxes on labor, and they are also part of the total labor costs that employers face. By definition, a VAT is the charge per unit of revenue enhancement placed on the value added by a business by employing capital letter and labor. The added value is measured by the deviation betwixt the purchase cost of materials and the auction of those materials (virtually often after a business turns those materials into something more useful). Though businesses may heighten prices to pass the toll of a VAT or sales revenue enhancement on to consumers in the short run, over the long run, the economic incidence of the VAT falls on workers.^[sixteen]

[1] Robert Bellafiore, "America Already Has a Progressive Tax Arrangement," Tax Foundation, January. 11, 2019, https://taxfoundation.org/america-progressive-taxation-organization/.

[2] OECD, "Taxing Wages 2020," Apr. 30, 2020, https://oecd.org/ctp/tax-policy/taxing-wages-20725124.htm.

^[3] Scott A. Hodge and Bryan Hickman, "The Importance of the Taxation Wedge on Labor in Evaluating Taxation Systems," Tax Foundation, 2018, https://files.taxfoundation.org/20180913095728/Global-Primer_tax_wedge.pdf.

[iv] Scott A. Hodge, Jared Walczak, Karl Smith, and Daniel Bunn, "Tax Policy Later Coronavirus: Clearing a Path to Economic Recovery," Tax Foundation, Apr. 22, 2020, https://taxfoundation.org/coronavirus-economical-recovery/.

[5] Amir El-Sibaie, "2020 Taxation Brackets," Revenue enhancement Foundation, November.fourteen, 2019, https://taxfoundation.org/2020-tax-brackets/.

[six] Social Security Administration, "OASDI and SSI Program Rates & Limits, 2020," Oct 2019, https://ssa.gov/policy/docs/quickfacts/prog_highlights/index.html.

[7] "Form 940 – Employer'south Almanac Federal Unemployment (FUTA) Taxation Return – Filing and Deposit Requirements," Internal Revenue Service, https://irs.gov/taxtopics/tc759.

[8] This is also known equally the relative elasticities of supply and demand for a taxed proficient.

[9] See generally, Taylor LaJoie, "The Child Tax Credit: A Primer," Revenue enhancement Foundation, April. fourteen, 2020, https://taxfoundation.org/child-taxation-credit/ and Robert Bellafiore, "The Earned Income Revenue enhancement Credit: A Primer," Tax Foundation, May 21, 2019, https://taxfoundation.org/earned-income-revenue enhancement-credit-eitc/.

[10] Garrett Watson, "Marginal Tax Rates on Labor Income in the U.South. After the Tax Cuts and Jobs Act," Revenue enhancement Foundation, Feb. 20, 2020, https://taxfoundation.org/marginal-taxation-rates-on-labor-income-in-the-us-afterwards-2017-tax-police/.

[11] OECD, "Taxing Wages 2020."

[12] Ibid.

[13] See generally, Garrett Watson, "Improving the Federal Tax Arrangement for Gig Economic system Participants," Tax Foundation, October. 18, 2019, https://taxfoundation.org/gig-economy-workers/.

[fourteen] OECD, "What Drives Consumption Tax Revenues?" 2020, https://doi.org/10.1787/94ed8187-en.

[15] The most recent OECD information available for the VAT revenue ratio is from 2017. VAT rates are from 2018. The U.S. sales tax rate is the boilerplate of all U.S. state sales tax rates (weighted past population); see Jared Walczak and Scott Drenkard, "Country and Local Sales Tax Rates 2018," Tax Foundation, Feb. xiii, 2018, https://taxfoundation.org/land-and-local-sales-tax-rates-2018/. The U.Due south. sales taxation revenue ratio was calculated equally the ratio of the implicit sales tax base of operations to state personal income.

[16] Eric Toder, James R. Nunns, and Joseph Rosenberg, "Implications of Dissimilar Bases for a VAT," Tax Policy Eye and The Pew Charitable Trusts, Feb. 14, 2012, https://taxpolicycenter.org/publications/implications-different-bases-vat/full.