Is a Payroll Tax a Pig in a Poke?

by Bill Cibes

Secret plans are not a common occurrence at the state Capitol, which often functions as an echo chamber. Yet a plan to scrap the state’s personal income tax in favor of a payroll tax was a largely held secret until Dan Haar of The Connecticut Post reported on it in his column a short time ago.

Although the plan is likely to go nowhere this legislative session, it nonetheless has produced a lot of discussion and speculation.

And while the idea of increased revenue from this radically different revenue-raising proposal may sound attractive on the surface, I and many others are severely skeptical about any plan that surfaces at the last moment, with little opportunity for anyone to examine the details and consider its ramifications. The legislature should NOT buy a pig in a poke. At the very least, this proposal should be thoroughly vetted and questions satisfactorily answered.

Indeed, there may be answers to many of these concerns – and to others that might be raised. But there certainly isn’t enough time to adequately scrutinize all the potential problems before the session ends in less than a month. Consider the following:

• The state’s personal income tax was designed to be progressive despite it being called, originally, a flat tax. There was and is a large exemption at the bottom of the income scale [and several steps as income increases (until, at $100,500 for joint filers there is an addback to pick up the tax on income taxed at 3 percent, and at $400,000 for joint filers, there is a reach back to pick up income segments which were taxed at lower rates)]. But a payroll tax would have no exemptions, so wages from dollar one would be subject to a 5 percent (per the example) tax. Essentially it appears that there is a reach back to dollar one for relatively low-income and moderate-income folks. If wages were reduced to pass through this payroll tax, the effect would be highly regressive.

• Accordingly, there would need to be some way to reimburse employees for this lost income – and an Earned Income Tax Credit (EITC) has been suggested. However, not everyone who is currently eligible for an EITC applies for it – and it is likely that would also be the case for an EITC to offset the payroll tax.

• It could be said that an EITC would automatically be paid out to eligible wage earners – but how would those wage earners be identified – and how would their payout be distributed? Employers would presumably identify by SSN those wage earners for whom a payroll tax was paid, as well as report the amount of the tax for each earner, just as is the case with FICA. But how would the EITC be paid back to the earner? And would it be adjusted for the size of family, as the current EITC is?

• If the minimum wage were to be increased at the same time as, or in close conjunction with, the startup of a payroll tax, there would likely be a huge political outcry from employers who are already upset with the idea of having to pay higher wages because of a higher minimum wage. They would likely contend that a payroll tax would be just another whack at their profitability.

• A payroll tax would presumably be paid only on wages paid to “employees.” Would there be a rush to reclassify current employees as “contractors?”

• How would the state identify which employers would have to pay a payroll tax? The easy answer might be that folks who currently pay the FICA tax would be identified as those who must pay the payroll tax as well (assuming that the state has access to that individually identifiable data). But the number of those who currently pay individuals “off the books” would likely increase if a payroll tax is implemented.

• How would tip income be taxed? Many low- and moderate-income taxpayers are in jobs with tip income. Would tip income be classified as wages?

• How would the payroll tax be integrated with an income tax on non-wage income? Would there be a separate rate schedule for non-wage income?

• Wouldn’t the Department of Revenue Services’ workforce have to be greatly expanded to handle the detailed implementation of a scheme that would have many moving parts? What if, logistically, it turns out that the tax department can’t handle it?

• There seems to be an assumption that as a payroll tax is phased in, wage earners might not receive a wage increase because the employer would pass on the payroll tax in the form of decreased wages (or at least hold the line on increased wages). This would probably not be greeted with enthusiasm by wage earners, who would see no such limits placed on non-wage income.

• Would collective bargaining agreements be superseded or voided in order to pay a wage reduced by the amount of a payroll tax?

• Would employers have the discretionary authority to reduce wages to offset a payroll tax? Must any reduction in wages equal the amount of the payroll tax – or could it be greater?

• If wages were to be reduced by 5 percent, would there be a long-term adverse impact on Social Security benefits – which are tied to the amount of wages earned over the course of a person’s working life? Contributions to a 401(k) plan would also be affected.

• This proposal seems to have been concocted as a way to circumvent the admittedly discriminatory (to states like Connecticut) limitation on the amount of state and local taxes that residents can deduct on their federal tax returns, as the result of the recently enacted federal tax law. But the Internal Revenue Service has taken a dim view of other efforts to do an end-run around this limitation. Would the IRS reject this plan in mid-year, possibly leaving Connecticut’s revenue structure in chaos?

If the legislature should buy into this concept without carefully inspecting the detailed text of a bill that outlines exactly what would be involved, without a public hearing, and without a critical analysis of concerns like those raised here, it seems more than likely that a porcine creature could spring out of the legislature’s bag of tricks at the last minute. And that would be a disaster for Connecticut and its taxpayers.


Bill Cibes is Chancellor Emeritus of the Connecticut State University System; was formerly Secretary of the Office of Policy and Management under Gov. Lowell P. Weicker, and a gubernatorial candidate.

Michele Jacklin contributed editorial assistance to this article.