How to Expose Hidden Taxation

April 13, 1998 • Commentary

By Dean Stansel

This article originally appeared in Investor’s Business Daily.

A puzzling economic trend in the U.S. over the past twenty years has been the relative stagnation of wages. Few economists have discussed one of the primary reasons for flat wages: taxes and other government mandates on employers have been steadily expanding. That makes it more and more expensive to keep workers on the payroll. While total employee compensation costs have been rising, real take‐home pay has not. It has been crowded out by the growth of taxes and employer mandates, many of which are hidden.

To better understand how the burden of taxation is hidden from us, try the following thought experiment. Imagine that you are an average manufacturing wage worker. Twice a month, your gross salary costs your employer $1,133.33. However, after unemployment insurance, workers’ compensation, and the employer share of the payroll tax are included, your employer must spend a total of $1,289.76. After income and payroll taxes are withheld, your take‐home pay is only $934.73.

Now, assume that our current system of withholding and employer‐paid taxes no longer exist. Your paycheck is made out for the entire $1,289.76 your employer pays to keep you on payroll, rather than your previous take‐home pay of $934.73. However, you now must pay each and every one of the various government‐imposed costs yourself.

One of the most effective ways to address the problem of hidden taxation is to eliminate the federal income and payroll taxes. The visibility of our tax system could be increased by replacing those taxes with a national sales tax paid directly by consumers every time they make a purchase.

Every time you receive your paycheck, you must go to a series of windows and pay the cashiers behind each counter.

At the first window you pay $86.70 for the “employer share” of the Social Security/Medicare payroll tax.
At the second window you pay $58.12 for the workers’ compensation contribution.
At the third window you pay $9.28 for the state unemployment insurance tax.
At the fourth window you pay $2.33 for the federal unemployment insurance tax.
At the fifth window you pay another $86.70 for the employee share of the Social Security/Medicare payroll tax.
At the sixth window you pay $85.31 for the federal income tax.
Finally, at the seventh window you pay $26.59 for the state income tax.

You have now paid the government its $355.03 share. As a result, your new paycheck of $1,289.76 has shrunk by roughly 28 percent to $934.73. Of course, you will then have to pay a host of other taxes–property taxes, sales taxes, gasoline taxes, cigarette taxes, alcohol taxes, etc.–out of your remaining take‐home pay.

In contrast, under our current system, you would simply have received a paycheck for $934.73. If you took the time to examine your pay stub, you could have learned that your gross salary was $1,133.33, and that the government had withheld $198.60 from you in income and payroll taxes. However, the additional $156.43 that your employer remits to the government on your behalf would have been completely hidden from you.

Over the period of a year, that amounts to an additional $3,800 that your employer pays to keep you on the payroll. But you would not receive one penny of that amount. The government takes it all without even giving you any notice that it has done so. That is the essence of our hidden burden of taxation.

Those hidden taxes distort the political process by reducing the perceived tax‐price of government services, making it easier for politicians to expand the size and scope of government. A recent Cato Institute study recommends three specific reforms that would help remove the veil of secrecy and expose the true cost of government employment and tax policies.

One of the most effective ways to address the problem of hidden taxation is to eliminate the federal income and payroll taxes. The visibility of our tax system could be increased by replacing those taxes with a national sales tax paid directly by consumers every time they make a purchase.

Short of such fundamental tax reform, repealing the deceptive practice of tax withholding and encouraging employers to adopt the Right to Know Payroll Form–first introduced by the Mackinac Center for Public Policy in Michigan–would also serve to make the tax burden more visible. That form itemizes on workers’ pay stubs each and every cost that is borne by the employer on the worker’s behalf as a result of government tax and regulatory policies.

Until our tax burden is made more visible, Uncle Sam will continue to take a larger and larger bite out of our take‐home pay.