PAYROLL TAX

levy imposed on wages and salaries. In contrast to income taxes, payroll taxes do not include income from capital sources, e.g., dividends or interest. Taxes on payrolls are seldom used as a source of general revenues, although in some developing countries the income tax base may actually include little beyond wages and salaries, the equivalent of the payroll tax base. Many countries do, however, levy payroll taxes to finance social security benefits, which include retirement and survivors' benefits, disability insurance, and health care. Payroll taxes are often justified by the appearance of a link between the taxes paid (often called contributions) and the benefits received; in fact, this link is commonly quite tenuous. With the maturity of social security systems around the world, payroll taxes have become an extremely important source of revenue. In the United States, for example, only the individual income tax is more important than the social security taxes, which are far more important than the corporation income tax. Because of international differences in both social security programs and the extent of reliance on general revenues, however, payroll tax systems and rates vary widely among countries. Payroll taxes are often levied on both the employer and the employee, presumably on the assumption that the ultimate burden will be borne in a similar manner. In fact, the theory of tax incidence suggests that the two components of the levy will have exactly the same incidence in the long runon labour; it is only in the short run that employers may be adversely affected by their portion of the tax (and even then they might be able to shift the tax onto consumers). Payroll taxes are virtually always collected through withholding. Unlike income taxes, payroll taxes usually make no allowance for the personal circumstances of the taxpayer, and rather than being levied at graduated rates, payroll taxes often do not apply to income above a ceiling. The tax is thus likely to be regressive, both because of the ceiling on taxable payrolls and because labour income represents a declining fraction of total income as income rises. This effect, however, may be more than offset by the distribution of social security benefits, the majority of which are commonly allocated to the poor. Charles E. McLure, Jr.