How Much Will Taxes Lower Your Paycheck?

Thanks to the recent presidential election and people like Joe Wurzelbacher, aka Joe the Plumber, a bright national spotlight has been placed on President Barack Obama's plan to raise income taxes on Americans making more than $250,000 a year.

Something that passed by with much less attention and fanfare is Obama's proposal to raise the cap on Federal Insurance Contributions Act taxes which, unlike federal income taxes, cannot be creatively lowered with the help of a great accountant because all taxpayers have FICA automatically deducted from their paychecks before they even receive them.

"There's no getting around (FICA). If you are self-employed, it's based on the profit your company made as opposed to revenue," said Brian Compton, president of Tax Resolution Service, Co. in Encino, Calif.

FICA is a tax that funds Social Security and Medicare.

But how much would a FICA increase cost the average taxpayer, and would an increase save Social Security and Medicare?

What Is FICA?

Currently, every employee and employer pays 7.65 percent of their income toward FICA. For independent contractors and those that are self-employed, they pay both the employer and employee amount, which totals 15.3 percent.

The tax for Social Security ends at the first $102,000 in earnings, but there is no cap for taxes on Medicare, according to the IRS's Web site.

Under Obama’s plan, the cap would be lifted for those making more than $250,000 a year, who would pay in the range of 2 to 4 percent more. The plan calls for a "donut hole" on income between $102,000 and $250,000, which would not be taxable.

FICA has been in effect since it was passed in 1935. While the percentage that Americans pay rarely changes, the cap on the amount that is taxable is a number that has rapidly grown this decade.

In 2000, the cap was $76,200, and it has increased each year since up to the current $102,000 for 2008.

Considering how little attention was paid to Obama's proposal on raising the FICA cap by the media during the election, the law could be passed with little notice from the public.

"I don't think there will be any push back on (the FICA cap), and it will go by relatively unnoticed … Joe the Plumber wasn't talking about it," said Compton.

Under Obama's plan, a FICA cap raise could have a huge impact on wealthy taxpayers' pocketbooks.

The argument is that they're rich so they can afford it. But the more conservative thought is that rich people own their own businesses and when they have less money to invest in their company, they must start cutting wages, benefits and jobs. While the superrich can probably take the hit, it's those people like Joe the Plumber claimed to be -- business owners making just over $250,000 -- that would be hardest hit.

What Is FICA's Return Rate?

In the end, your FICA contribution is meant to provide a security blanket, and there is a sliding scale based on how much you contribute relating to how much you get back when you retire. But the amount will not be above a subsistence level for rich Americans who have paid into the system for many years.

"Over the course of a year, (rich retirees) may get $10,000 to $25,000 in terms of Social Security, which is well less of whatever they paid in over the years," said Compton. "It is not designed to be based on what you paid in. There is some indexing based on income levels, but it's very modest compared to what you get for typical investments."

According to the Federal Reserve Bank of San Francisco's Web site, those in the bottom 20 percent of the income bracket can expect a rate of return between 4 and 5 percent, adjusted for inflation. Middle income workers can expect a rate of return of 1 to 2 percent, and high income workers can expect a rate of return below 1 percent, and may even face a negative return if they were born after 1975.

Will A Cap Raise Save Social Security?

According to the Social Security Board of Trustees, a shortfall and then insolvency of the system is rapidly approaching.

A statement by Treasury Secretary Henry Paulson that was released in March 2008 concluded that in fewer than 10 years, "cash flows are projected to turn negative -- meaning that we will draw upon general revenues to support withdrawals from the Trust Funds in order to pay current benefits. The Trust Funds are projected to be exhausted in 2041."

Most experts agree that raising the FICA cap will help, but not solve, the problem.

The Washington Post concluded in an article on July 8, 2008, that Obama's proposal would generate about half of the estimated $4.3 trillion shortfall Social Security is expected to face in the next 75 years.

While a cap raise will help raise Social Security funds, it also helps deliver the broader economic message of Obama, which is his desire to "spread the wealth around," as he told Joe the Plumber on the campaign trail.

"(A cap raise) won't solve the problem percentage-wise," said Compton. "There aren't that many people in the country that make north of $250,000 a year. There's a bunch of people that do, but the total percentage is not that high. It does help raise additional funds, but it also communicates to a broader cross section of taxpaying America, 'Hey, we want things to be fairer for you.'"