This working paper combines theory and existing empirical evidence to revisit the extent to which payroll taxes are passed through to employees. The estimates rely on stylized models and are complemented by a discussion of the empirical literature on payroll tax incidence.
By Dorian Carloni
Empirical evidence on the incidence of payroll tax changes in the United States is limited and does not generally apply to changes in U.S. federal payroll taxes. Economic models can help inform the effects of such changes on households’ well-being—that is, their welfare effects. In this paper, I rely on partial equilibrium and general equilibrium models to quantify the welfare effects of payroll tax changes.
First, I develop a partial equilibrium model of tax incidence and evaluate the short-run incidence of payroll tax changes on employees in the United States and then estimate that model using a sample of U.S. tax returns and existing estimates of labor supply and demand elasticities. I estimate that 58 percent of the additional tax burden created by an increase in the payroll tax rate applicable to all earnings would fall on employees in the short run, with the remainder falling on capital and other nonlabor factors of production. The predicted burden on employees for tax changes that apply only to taxable earnings at certain levels of earnings would vary. Specifically, I estimate that 23 percent of the tax burden from an increase in the Medicare surtax rate and 62 percent of the tax burden from an increase in the Old-Age, Survivors, and Disability Insurance tax rate would be shifted to employees in the short run. Although I estimate that employees would bear only a portion of the burden of increases in tax rates, I find that employees would bear more of the full burden of increases in payroll taxes that result from changes in tax thresholds or increases in the share of total compensation that is taxable.
I complement the partial equilibrium analysis by discussing the joint incidence of payroll tax changes and the use of the change in revenues in a general equilibrium model, which accounts for additional longer-run effects of those tax changes. I show that the long-run incidence of the tax would depend on the macroeconomic effects of the tax changes considered and illustrate the effects of alternative payroll tax changes under the same use of the revenues. Finally, because of limitations of the theoretical analysis, I relate those estimates to those provided by the recent literature on other countries and discuss how the insights from those studies can further inform the analysis of payroll tax incidence in the United States.