Why your raise feels smaller than the number your boss pays out

Every job in America has two prices. The first is what the business pays to have a person in that chair. The second is what lands in the person's bank account. Nobody ever shows you both numbers on the same page, and the space between them is one of the biggest facts of working life that most people have never once been told about.

Think of it as a wedge. On one side of the wedge sits the employer's total bill. On the other side sits your take-home pay. Everything in between is taxes, insurance premiums, mandates and benefits, some of which you wanted and some of which you never chose. I'm going to explain how the wedge is built, who the economists say really pays for it, why a raise feels smaller than the number your boss quotes, and what a family can do with the knowledge. The tone I want to hold here is of a man at a whiteboard rather than a man on a soapbox, because this one is mostly arithmetic.

The two prices of a $60,000 job

Take a hypothetical worker with a salary of $60,000. That is the number on the offer letter. It is the number the worker tells his in-laws. It is also, I will argue, the least interesting number in the story.

The first layer of the wedge is the payroll tax that funds Social Security and Medicare, known as FICA from the Federal Insurance Contributions Act. The tax comes in two parts. Social Security is 6.2 percent of wages up to an annual cap that Congress adjusts and the Social Security Administration publishes, and Medicare is 1.45 percent of all wages. Add them: 6.2 plus 1.45 is 7.65 percent. And here's the thing that surprises people: that 7.65 percent is charged twice. The employee pays it out of his wages, and the employer pays a matching amount on top.

On a $60,000 salary:

• The employer's half is 7.65 percent of $60,000, which is $4,590.
• The employee's half is also $4,590, withheld from his pay.
• Together that is $9,180, or 15.3 percent of the salary.

A $60,000 salary is below the Social Security wage cap in any recent year, so the full 7.65 percent applies. (If your wages are above the cap, check the Social Security Administration's current figure.)

So before this man has a single dollar of benefits, the business already spends $60,000 plus $4,590, which is $64,590. The worker's check is smaller than $60,000 by his own $4,590 and by whatever income tax is withheld.

The layers under the first layer

The employer share of FICA is only the first layer. There are others.

Federal unemployment tax (FUTA). The employer pays a federal tax on the first $7,000 of each employee's wages. The statutory rate is 6.0 percent, and with the full credit for state unemployment taxes paid on time, the effective rate is usually 0.6 percent. That is 0.6 percent of $7,000, which is $42 a year. The worker pays none of it directly. The new employer's checklist in the new employer's checklist for the first year of payroll and taxes walks through the filing.

State unemployment insurance. Each state runs its own program, funded mostly by employer taxes, with rates that depend on the state, the employer's history of layoffs, and a wage base that varies. A business with many layoffs pays more. I will not give you a number because it varies too much from place to place. Look up your state workforce agency.

Workers' compensation. Nearly every state requires employers to carry insurance for on-the-job injuries. Premiums depend on the job class and the state, which is why a roofer costs more to insure than an office clerk. Workers' compensation was a trade, in its origin: the injured worker gets medical care and a portion of lost wages without having to sue, and the employer is protected from most lawsuits. Wisconsin enacted the first state law of the modern type in 1911, and the other states followed. It's a reasonable bargain, but it has a price.

Mandates and compliance. Federal and state laws add leave requirements, posting and recordkeeping requirements, and, for larger firms, health insurance rules. The Family and Medical Leave Act of 1993 gives eligible employees up to twelve weeks of unpaid, job-protected leave at employers with 50 or more employees, and the Affordable Care Act of 2010 set an employer coverage requirement for firms with at least 50 full-time-equivalent employees. These rules have costs even when no one invokes them: the paperwork, the planning for absences, the need to hire coverage.

Benefits. Health insurance premiums, retirement contributions, paid time off. These are real compensation, and often valuable.

Add it all up and the employer's cost of this $60,000 worker is easily above $64,632 ($60,000 plus the $4,590 and $42 so far, before state unemployment tax, workers' compensation, and benefits). Employers and the government have a name for the total: total compensation. The worker usually sees only one line of it.

Who really pays the employer's half?

Now the part economists argue about, and where I think the weight of the evidence is clear enough to say out loud.

The law says the employer pays the employer's half of the payroll tax. That is the statutory incidence: who sends the check. But the economic incidence, who actually bears the burden, can differ from who writes the check. Think about it from the boss's side. He has a budget for this position. Whether he thinks of it as $64,590 or as $60,000 plus a tax, the total he is willing to spend on the person is what matters to him. If the government raises the employer's tax, the budget is the same, so there is less left over for wages. If the government cut the employer's tax, a competitive labor market tends to push wages up over time, because other employers want the workers too.

That is the standard economic view, and the evidence supports it. Jonathan Gruber of MIT studied a Chilean reform in the 1980s that cut employer payroll taxes and found that wages rose by roughly the amount of the cut, with little effect on employment in the study. The Congressional Budget Office and the Joint Committee on Taxation follow the same view in their distribution tables: they treat the employer's share of the payroll tax as borne by workers, in the form of lower wages than they would otherwise earn.

There are limits. The adjustment takes time. It works best in competitive markets where wages can move. Where wages can't fall, say because of a legal floor or a union contract, the burden may land on the employer's profit or on employment. The best way to put it is that over the long run, workers bear much of the employer's share, and in the short run it depends. That is a factual claim about incidence, and thoughtful economists on both sides accept most of it. What you do with the fact is a value claim, which I'll come to.

The arithmetic of a raise

Let me make it concrete with the raise that gives this post its title. Suppose the employer gives the $60,000 worker a $3,000 raise. Assume, for the example, that the worker's marginal federal income tax rate is 12 percent, and ignore state taxes.

What the employer pays:

• The raise itself: $3,000.
• The employer's FICA on the raise: 7.65 percent of $3,000, which is $229.50.
• The total added cost: $3,000 plus $229.50, which is $3,229.50. (The FUTA wage base of $7,000 was already used up, so there is no added FUTA.)

What the worker keeps:

• The raise itself: $3,000.
• The worker's FICA: 7.65 percent of $3,000, which is $229.50.
• Federal income tax at 12 percent: $360.
• Take-home: $3,000 minus $229.50 minus $360, which is $2,410.50.

So the employer spends $3,229.50 and the worker gets $2,410.50. Divide $2,410.50 by $3,229.50 and you get about 0.746. For every dollar the boss spends on the raise, the worker nets about 75 cents. The other 25 cents went to the government. Not a fraud, not a mistake, just the system working as designed. And it is why a worker whose boss says "I gave you a $3,000 raise" may feel that something is missing in his check.

If the worker were self-employed, the picture would be starker. A self-employed person pays both halves of the Social Security and Medicare tax, a combined rate of 15.3 percent, applied to 92.35 percent of net earnings, with a deduction for half of the tax. He sees the wedge in plain sight, which is one reason small-business owners tend to be tax-literate in a way that salaried employees often are not.

How health insurance got stuck to the job

One of the thickest layers of the wedge has a surprising history, and it explains something about American life that people take for granted: why your health insurance comes from your boss.

In 1942, with the country at war, Congress passed the Stabilization Act of October 2, 1942, which gave the President authority to stabilize wages and prices. Wages were frozen, effectively, at set levels. Employers who needed workers for war production couldn't compete by paying more. So they competed another way. The National War Labor Board, which administered the wage controls, allowed certain fringe benefits, including health insurance and pensions, to be offered without violating the wage limits. Companies began offering health coverage to attract workers.

Then came the tax treatment. In the 1940s, tax authorities took the position that employer-paid health premiums were not taxable wages to the employee. And in the Internal Revenue Code of 1954, Congress wrote the exclusion into the statute, in section 106. From then on, a dollar of employer-paid health insurance was exempt from income tax and payroll tax, while a dollar of wages was not.

I will not give you medical advice, nor am I here to attack employer coverage, which millions of families depend on. I am describing a tax rule. Here is its effect in numbers, with a hypothetical worker in the 12 percent bracket.

Suppose the employer has $1,000 to spend on this worker, either in wages or in health premium.

• As a premium: the worker receives $1,000 of coverage, with no income tax and no payroll tax on it.
• As wages: the employer's cost of wages W includes the 7.65 percent employer tax, so W times 1.0765 equals $1,000, and W is about $928.95. The worker then pays 7.65 percent FICA, which is about $71.06, and 12 percent income tax, which is about $111.47. His take-home is $928.95 minus $71.06 minus $111.47, which is about $746.42.

So $1,000 of premium is worth $1,000 of coverage, while the same $1,000 in wages is worth about $746 in take-home. The tax code tilts the choice toward insurance bought through the job. That tilt is why so many employers and employees prefer it, and it is why changing jobs can mean changing insurance. It also means that a share of what might have been wages went into premiums, which the worker never saw as pay. For how the system treats older Americans, see Medicare part by part, what A, B, C and D cover and who pays.

The best argument that this is not a wedge at all

The other side has a strong response, and I want to give it fairly.

Much of what you call a wedge is not a loss. Payroll taxes buy Social Security retirement and disability benefits and Medicare, which you will use. Unemployment insurance protects you if you lose your job. Workers' compensation protects you if you are hurt. These are forms of insurance that most workers could never buy individually at the same price, because of adverse selection. Mandates like family leave protect workers who would not have the bargaining power to ask. Calling these a "wedge" is like calling your car insurance premium a loss.

That is partly right, and I accept the part that is right. A payroll tax that buys a benefit is different from a tax that buys nothing. And I would not abolish workers' compensation, which solved a real problem when injured workers had to sue to get help.

Now the reply. First, a benefit that you value at less than its cost is still a loss to you; the claim "you get something for it" does not settle whether the price is right. Second, you do not get to choose. A twenty-five-year-old who would rather put the money in a down payment than in a promise from the 1935 system, a promise explained in How Social Security works and the promise built into its 1935 design, has no option to opt out. Third, the benefit and the cost are separated in your mind. You see the tax on your stub and the benefit forty years later, and the employer share you don't see at all. A hidden cost is easier to raise than a visible one, which is a good reason for citizens to demand the visibility.

That is the value claim I promised. The factual claim, that workers bear much of the cost, is on solid ground. Whether the trade is a good one is a judgment, and reasonable people differ.

What a family can do with this

1. Ask for the total compensation figure. Many employers will give you a statement of total rewards that adds the employer's share of taxes and benefits to your pay. Ask for it. It is the other price.
2. Compare offers on total compensation. A job at $60,000 with strong benefits and a job at $64,000 with none are not what they seem. Do the arithmetic on your own family's needs.
3. Read your pay stub with a pencil. The worksheet in a paycheck worksheet that shows where every dollar of your pay goes shows each line.
4. Use the right mental model for a raise. When a raise is offered, figure out the after-tax number, as above. It is the figure that pays your bills. The same logic explains the confusion untangled in seven tax myths that scare working families and cost them money.
5. Support visibility. Ask your members of Congress and state legislators whether pay stubs and W-2s should show the employer's share of payroll taxes. A worker who sees both halves is a better-informed voter.

The bottom line

• Every job has two prices. On a $60,000 salary, the employer's half of Social Security and Medicare tax is 7.65 percent, or $4,590, before unemployment taxes, workers' compensation and benefits.
• Economists find that workers bear much of the employer's share over time, in lower wages than they would otherwise earn. The law says the employer pays. The economics says the worker does.
• In our hypothetical, a $3,000 raise cost the employer $3,229.50 and put $2,410.50 in the worker's pocket, about 75 cents on the dollar.
• Health insurance sits on the job because of wartime wage controls and the 1954 tax exclusion, which treats a premium dollar better than a wage dollar.
• Ask your employer for your total compensation, compare offers on that number, and press your legislators to make the hidden half visible.