For example in 2005 the social security tax rate was

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Unformatted text preview: urity, the Social Security tax has been split between the employer and the employee. For example, in 2005, the Social Security tax rate was 12.4 percent. Half of this tax, or 6.2 percent, was placed on the employer, and the other half was placed on the employee. In other words, the employee was expected to pay $6.20 per $100 of gross earnings (up to a limit), as was the employer. It is commonly believed that if a tax is placed on someone, then that someone actually pays the tax. However, the placement of a tax is different from the payment of a tax. Just because the government places a tax on Anderson, it does not necessarily follow that Anderson pays the tax. The same is true for the Social Security tax. Just because the government places half the tax on the employer does not necessarily mean that the employer pays the tax. To better understand this concept, suppose the Social Security tax is $2 a day and that $1 of the tax is placed on the employer and $1 placed on the employee. An earlier 368 Chapter 14 Taxing and Spending Page 368 chapter explained that wage rates are determined by supply and demand. For example, the demand for labor and the supply of labor go together to determine the wage rate. Suppose that the equilibrium wage rate before the tax is placed on the employer is $10 an hour. What will the tax that is placed on the employer do to the employer’s demand for labor? A tax will lower the employer’s demand for labor. Employers will not want to hire as many employees as they might otherwise, if they have to pay a $1 tax per employee per day. In other words, as a result of the Social Security tax being fully placed on the employer, the demand for labor falls. Now if the demand for labor falls, and the supply of labor is constant, we know (through our supply-and-demand analysis) that the wage rate will fall, say, from $10 an hour to $9.35 an hour. So, in our example, have employees paid for any of the Social Security tax that was placed on the employer? Yes, they have paid in terms of lower wages. In other words, without the tax, employees’ wages would be higher ($10 an hour) than they are with the tax ($9.35 an hour). Some of the Social Security tax (in our example, 65 cents of the $1 tax) is paid for by the employees in the form of lower wages, even though the tax was placed on the employer. The first moral of the story is this: many people think that the employer pays half the Social Security tax and the employee pays the other half when, in fact, the employee ends up paying more than half the Social Security tax. The employee pays the employee half of the tax, and then pays some of the employer’s part of the tax in the form of (earning) lower wages. Second moral of the story: the legislature can place a tax on anyone it chooses, but it is not the legislature that determines who pays the tax. The laws of economics (in this case, the laws of demand and supply) determine who pays the tax. THINK ABOUT IT Every market has two sides: a demand side (buying side) and a supply side (...
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