LESSONS LEARNED #81: “Gross pay is a myth.” – Old Pithy

Posted by PITHOCRATES - September 1st, 2011

We Earn More than our Fathers but Can’t Buy as much as They Did

A paycheck just doesn’t seem like it goes as far as it used to.  And there’s a reason why it seems like that.  Because it really is like that.  Our paychecks can’t buy as much as they used to.  Not as much as our father’s paychecks.  And our father’s generation raised bigger families.  So why is that?  How can we earn more than our fathers.  But can’t buy as much as they did?

Two reasons.  Taxes.  And inflation.  One took our money away.  The other made what money we had worth less.

Big taxes came with Big Government.  Government went through some major spurts of growth.  The first being under Woodrow Wilson in the 1910s.  Then the New Deal era of FDR.  In the 1930s and into the 1940s (he was president for a very long time).  Followed by the Great Society era of LBJ.  In the 1960s.

During the 1950s a Gap began to Grow between Gross Pay and Net Pay

Abraham Lincoln gave us a federal income tax.  He did it to pay for the Civil War.  After it served its purpose, government repealed it.  Then Wilson brought it back.  And it was back to stay.

Then FDR gave us Social Security.  And a new payroll tax to pay for it.  Among other government programs.  Then LBJ gave us Medicare.  And a new payroll tax to pay for it.  Among other government programs.  This was a lot of new federal spending.  Paid for with a lot more federal taxes.

These taxes added up.  Especially for a young family starting out.  During the 1950s, a gap began to grow between gross pay and net pay.  And continued to grow through the 1960s.  Payroll taxes were growing.  And eating into our earnings.  There were federal, state and city income taxes (in some cities).  Social Security and Medicare.  Starting slowly.  Then taking off during the Seventies.  To pay for all those new government programs.

The Trend has been Less Money in the Working Man’s Pocket because of Higher Taxes

Let’s take a look at one city.  Detroit.  The Motor City.  Once the veritable capital of the industrial world.  Where a working man could once earn enough to raise a family of ten.  And many did.  They can’t do that anymore.  Not without a second income.

Let’s crunch some numbers.  And graph them.  Let’s look at gross pay and net pay from 1920 to 2010.  The following chart shows these results.  All dollars are constant 2010 dollars.  We started with a gross pay of $36,840 (see Center of Nutrition Policy and Promotion’s 2010 annual report, page 26) in 2010.  This represents a young family starting out.  At the beginning of both family.  And career.  Then we calculated this amount going back to 1920 in ten year intervals in 2010 dollars.  We then calculated annual amounts for income taxes (federal, state and city).  And Social Security and Medicare taxes (employee portion only).  We then graphed gross pay, payroll taxes and net pay (gross pay less payroll taxes).

This chart shows a general trend.  We did not factor in tax exemptions or credits.  Nor did we look at property taxes or the myriad of excise taxes consumers pay.  Some of these will put more money into a consumer’s pocket.  Some will take more out.  So even though the following trend analysis is not exact, it should be close enough.  The trends should fairly represent the end affect on the average working man.  Less money in his pocket over time.

(Sources: federal income taxes, state income taxes, city income taxes, Social Security and Medicare taxes)

Payroll Taxes really bit into Earnings after 1970

Payroll taxes kick in after 1940.  And they rise steadily until (about) 1970.  Note that net pay increases at a slower rate than gross pay.  In other words, paychecks were ‘shrinking’ during this time.  As pay increased workers kept less and less of the amount they earned.

This period included Social Security.  In 1940 the employee paid 1% of his earnings up to $3,000.  In 1950 he paid 1.5% of his earnings up to $3,000.  In 1960 he paid 3% of his earnings up to $4,800.  In merely 30 years the tax rate increased 200%.  While the amount of your wages subject to this tax increased 60%.  And this was during the period of ‘moderate’ growth.

After 1970 all of the graphs bend up steeply.  From 1970 to 2010, the Social Security tax rate went from 3% to 6.2%.  This is an increase of 106.67%.  The amount of your wages subject to this tax went from $4,800 to $106,800.  This is an increase of 2,125%.

This is but one example.  Other taxes increased, too.  Obviously.  For payroll taxes really bit into earnings during this period of extraordinary tax growth.  So much so that net pay grew at even a lesser rate (than gross pay) than it did in the previous 30 years.  Opening up the gap between gross pay and net pay even larger throughout this period.

Gross Pay may have stayed Ahead of Inflation, but Net Pay Hasn’t

But there is something else.  Employers weren’t just overly generous after 1970.  Something else happened to push gross earnings up at that rate.  The Nixon Shock.  When President Nixon took us off the ‘gold standard’.  And ignited inflation.

We can see this clearly if we add the Consumer Price Index to this chart.  Which we do here.

 

 (Sources: federal income taxes, state income taxes, city income taxes, Social Security and Medicare taxes, CPI)

Gross pay shot up to stay ahead of inflation.  In fact, the growth rate of gross pay has kept ahead of the growth rate in the CPI.  Net pay, on the other hand, hasn’t.  The net pay graph is not as steep as the CPI graph.

So payroll taxes are increasing.  As are prices.  Which is a double hit on real earnings.  We may have never earned more, but we’re keeping less and less of what we earn.  And what we get to keep can’t buy as much as it once did.

Higher Taxes and Higher Prices have Shrunk Real Earnings

So paychecks have been shrinking.  Thanks to the increase in payroll taxes.  And prices have been rising at a faster rate than our net pay.  Which answers the question.  Why do we earn more than our fathers and yet we can’t buy as much as they did?  Because of growing prices.  And shrinking real earnings.

 www.PITHOCRATES.com

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