In the United States, the government-based retirement benefit plan and health care program are funded by payroll taxes usually noted as FICA (Federal Insurance Contribution Act) on an employee’s pay stub. FICA consists of two separate taxes: Social Security and Medicare. Both are calculated as a percentage of applicable gross wages.
FICA (Federal Insurance Contribution Act) was enacted in 1935 as an old-age pension plan, or Old-Age, Survivors, and Disability Insurance(OASDI). The fund, more commonly called Social Security after the Social Security Administration (SSA) that manages it, has become one of the largest line items in the United States budget. Social Security provides retirement benefits and disability payments to workers and their dependents. Medicare, which provides hospital and some health coverage for many of the same beneficiaries, is the other component of the FICA payroll tax.
Social Security is not an investment vehicle, is not subject to the marketplace, and is minimally tied to the economy. Recipients receive a fixed amount each month based on past earnings. The amount is reviewed by Congress each year and may be increased should the cost of goods and services rise, causing a cost-of-living adjustment (COLA).
The FICA tax rate is fixed each year, but is subject to increase or decrease by changes in federal law. It is calculated as a percentage of applicable earnings; most wages are applicable unless the wage earner belongs to particular labor groups. As of 2011, the Social Security portion of FICA was subject to a maximum earnings level that once exceeded was free from the tax.
FICA tax rates affect business as well. In most cases, the employer pays FICA taxes equal to the employee contribution. The total withheld from the employee's paycheck and the employer contribution is deposited with a federal bank within a few days of the pay being withheld from the employee. By running the program through the employer, the government obtains a higher rate of compliance and more timely payments. Self-employed persons are responsible for both the employee and employer amounts, although the employer amount may be deducted as a business expense.
From its inception in 1937 through 2011, FICA tax rates have ranged from 1% to 6.2% of gross wages. Typically, the employer contribution matches the employee contribution. The Medicare portion of the FICA tax rates is an additional tax, which has varied from its beginning in 1966, from 0.35% to 1.45% of gross wages in 2011. As of 2011, more than 15% of the national income (NI) was spent on payroll taxes.
At times, there have been some manipulations of the FICA tax rates to try to stir the economy. In 1984, for example, an immediate tax credit of 0.3% of wages forestalled the 0.3% regulated increase in the rate. The 2010 Jobs Creation Act included a one-time 2% decrease in the FICA employee tax rate for the 2011 reporting year.
FICA tax rates have been described as regressive because there is no standard deduction and FICA tax rates are not income based. Poorer employees pay more of their total wages into the fund than the more wealthy. Early in the plan’s inception, many groups were not required to join the new Social Security program. These included various civil servant or public service positions, including Congress, railroad employees, and some teachers and members of the clergy.