Social Security Taxes

Posted by PITHOCRATES - January 14th, 2013

Economics 101

The Employer has to Write the Check to pay the Full Amount of Social Security Taxes

Social Security taxes are one of the biggest expenses businesses have.  If you look at your paycheck you will see some withholding taxes.  Included in those taxes you will see Social Security.  Or FICA (which includes both Social Security and Medicare withholding taxes).  These are your contributions for your retirement.  But you don’t pay them.

The Social Security contribution is ostensibly split into two parts.  There’s the employee contribution (those taxes withheld from your paycheck).  And the employer’s matching contribution.  But the employer pays the whole thing.  Just like employers pay for unemployment taxes, workers’ compensation insurance, disability insurance, health insurance (for the most part, some employees contribute a portion these days), life insurance, paid vacation, paid holidays, paid sick days and pension contributions (for those who still pay pensions).  All of these benefit the employee, not the employer.  Yet the employer picks up the tab for these expenses.  And Social Security is no different.

Actually, there is one difference.  All of these employer-paid expenses reduce the employer’s taxable income.  Except one.  The employee’s Social Security contribution.  The employer has to write the check to pay the full amount of these taxes.  Paying the full amount (both employer’s and employee’s contribution) reduces the amount of cash they have on hand to pay their other bills.  The full amount of these Social Security taxes influence hiring decisions.  And once they pay these taxes it’s income they’ve earned they no longer have.  But they still pay income taxes on it.  Despite the employee paying income taxes on this same income.

One of the Largest Expenses a Business has is Social Security Taxes

So the employee does not pay Social Security taxes.  It’s just another on a long list of expenses an employer has to pay.  That said the employee’s contribution does reduce his or her net pay.  When President Obama cut the employee’s Social Security tax rate 2% the employee’s net pay increased.  While the employer matching portion remained at the same rate.  Yet the check the employer wrote for Social Security taxes reflected this 2% reduction.  Because the employer pays all of these payroll taxes whether it’s unemployment, workers’ compensation or Social Security.  The following chart summarizes sample labor costs.  Both at the Obama tax cut.  And after it expired.  For an employee with a gross annual pay of $66,360 (for 47.4 weeks of work plus 4.6 weeks paid time off).

Note the 2nd largest cost after health care is Social Security.  Both the employer’s and employee’s portion add up to $9,027 (both at 6.2%).  Which is a lot of money.  If an employer has 15 employees that Social Security check they have to write totals $135,408.  Half of which does NOT reduce an employer’s taxable income.  Assuming an effective tax rate of 26% (for a small business owner filing as a subchapter S or an LLC where their business earnings flow through to their personal tax returns) that’s an additional $17,603.04 ($4,514 X 15 X 26%) of taxes the employer has to pay on income that they receive no benefit from.

Under the Obama tax cut this employee had $1,456 less withheld from his or her paycheck.  Or $52 less a week.  Or $5.60 less a workday.  Almost enough to pay for lunch.  Or enough to make you stop going out to lunch.  For the 15 employees that’s $780 pulled out of the local economy each week.  For a city with 500,000 workers that’s $26,000,000 pulled out of the city economy each week.  That’s a lot of economic activity.  That can provide a lot of jobs.  So why let the Obama tax cut expire when they have such a positive effect on the economy?

Social Security is Going Bankrupt thanks to an Aging Population

Because Social Security is going bankrupt.  And the solvency of Social Security isn’t helped when you cut the only funding mechanism for it.  The Social Security tax.  That 2% reduction in the tax rate cost the retirees some $176 billion each year.  That’s why they let the Obama tax cut expire.  $176 billion is a lot of money for a program going bankrupt.  And it’s a lot of money for a government that runs a deficit.  Which is the real reason why they wanted to let the Obama tax cut expire.

When the government needs to pay for their deficit spending the Social Security Trust Fund is just too tempting to pass up.  All those payroll taxes flowing into the Social Security Trust Fund.  Just sitting there.  Not being spent.  It’s just too much for a politician to resist.  So they raid the Trust Fund. They take that cash and spend it.  Leaving behind a bunch of IOUs.  Treasury bonds.  The kind that can’t be bought or sold.  Non-negotiable.  Which means the only way to redeem these bonds (and to repay the Social Security Trust Fund) is by raising taxes, further borrowing or reducing benefits.  Such as raising the age when you can start collecting Social Security benefits.  All of which we’ve used to try to forestall the inevitably bankruptcy of Social Security.

So Social Security is a very complex thing.  Social Security taxes are a tremendous cost burden on businesses.  And they pull a lot of spending money out of the economy.  Reducing economic activity.  Yet as much money as they pull out of the economy it’s not enough.  Social Security is still going bankrupt.  Thanks to an aging population (the number of beneficiaries is growing at a greater rate than those entering the workforce to pay for these benefits).  And even though the rate of money flowing into the Social Security Trust Fund is falling it’s still large enough for politicians to raid to pay for other out of control spending obligations.  Ensuring that Social Security will go bankrupt no matter what tax rates are.

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Economies of Scale

Posted by PITHOCRATES - December 31st, 2012

Economics 101

Employers are very Reluctant to hire Additional Employees because Labor Costs are their Greatest Costs

When it comes to running a business there is nothing more costly than people.  Employee salaries and wages.  Payroll taxes.  And benefits.  People need a large paycheck to live on and will go to the employer that offers the highest pay.  Government has imposed costly taxes and regulatory costs.  And to further entice good workers employers have to sweeten the deal with some fringe benefits like health insurance, paid vacation time, holiday pay, paid sick days and retirement plans.  It adds up.  Something like this:

As you can see the amount of pay employees are familiar with (the working pay above) is far less than the total cost to the employer.  The employee doesn’t see the 63.1% markup on their working pay that their employer has to pay in addition to paying the employee.  As a business hires more employees these costs add up.  A small factory with 15 workers on the factory floor can cost the employer $1.6 million.  Which is why labor costs are the greatest costs of most businesses.  And why employers are very reluctant to add additional employees.

The more Productive you are the Lower your Unit Cost and the Lower the Selling Price in a Store

Besides labor costs a business like a factory will have material costs, too.  These are variable costs.  They’re variable because they vary with varying levels of production.  The more production there is the more variable costs there are.  In addition to variable costs businesses have fixed costs.  Often simply called overhead.

Factories make things.  Like things you can pick up off a store’s shelf.  Things with low prices on their price tags.  But when it can cost a small manufacturer $1.6 million JUST for its labor costs how can they sell things with such low prices?  By making a lot of those things to sell.  As much as they possibly can with their variable and fixed costs.  What we call economies of scale.  And the more they can make for their given costs the lower the unit cost is for each thing you can buy off a shelf at a store.   As you can see here:

Assuming a factory can produce anywhere from 1,250,000 to 2,750,000 units with a given labor force operating the same production equipment in a factory you can see how the unit cost falls the more they produce.  Which is why there is so much talk about productivity.  The more productive you are (the more you can produce for a given cost) the lower your unit cost.  And the lower the selling price in a store.  Increasing productivity could mean moving an assembly line a little faster.  Or replacing some people with machines.  Things that workers don’t like.  But things consumers love.  For they like low prices when they go shopping.

Employers are very Reluctant to Hire New Employees and Prefer Increasing Productivity with Automation

If you crunch these numbers for the labor costs of 16 and 17 workers you can see how unit costs rise as an employee or two is added to the production floor.  At an annual production of 2,000,000 units the unit cost increases $0.05 (4.6%) going from 15 to 16 workers.  Adding two workers increases the unit cost $0.11 (10.1%).  Doesn’t seem like a lot.  But we notice when something we once bought for $0.99 now costs $1.04.  And we don’t like it.  But business owners like it even less.  Here’s why.

Business may be booming.  Those on the factory floor may be working a lot of overtime to produce at a rate of 2,000,000 units per year.  And are growing unhappy with all of that overtime.  They keep demanding that the owner hire another person.  The owner does.  Increasing unit costs by $0.05.  But the owner hopes the booming economy will continue.  And that they can even increase the production rate.  For if they can sell an additional 250,000 units the unit cost can actually fall $0.07 to $1.02.  Making the addition of a new worker on the factory floor not increase costs.  As the increase in production will make costs fall greater than that increase in labor costs.

But it doesn’t always work like that.  Economic booms don’t always last.  When too many factories increase production to meet booming demand they bring too much supply to market.  Causing prices to fall.  And forcing factories to cut back on production rates.  So instead of increasing the production rate they may find themselves cutting back.  Perhaps going from 2,000,000 to 1,750,000.  A fall of 250,000 units.  Increasing the unit cost $0.21 (19.3%).  Which could very well raise the unit cost above the prevailing market price.  Requiring layoffs.  To get the unit cost back down to $1.09.  Allowing them to sell at the prevailing market price.  And at a production rate of 1,750,000 units that may require letting go more than just one worker.  Maybe even more than two.  Which is why employers are very reluctant to hire new employees.  And prefer increasing productivity with automation.  For it is far easier to make machines increase or decrease production rates than it is to hire and lay off people.  Making it easier and less costly to reach great economies of scale.  Which makes low prices.  And happy consumers.

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Labor Costs

Posted by PITHOCRATES - November 19th, 2012

Economics 101

Small Business Owners may have Nicer Homes but Chances are they are Mortgaged to the Hilt

A lot of people think business owners are cheapskates.  Greedy bastards.  Who hate their employees.  And try to pay them as little as possible.  Not for any business reasons.  But just because they are so greedy.  And hateful.  During bad economic times when the employer has to make some cuts labor leaders will tell the rank and file don’t believe the employer.  “Just look at the house the boss lives in.  And the house you live in.  Whose is better?  Bigger?  That’s right.  The boss’ house is.  Always remember that.”

Yes, bosses may have nicer homes.  But chances are they are mortgaged to the hilt.  Not to mention the fact that these bosses may be working an 80-hour week.  Which is not uncommon for a small business owner.  Especially during bad economic times.  As they may be negotiating with creditors, their banker, their vendors, keeping their customers happy and trying to find new customers.  While the rank and file work their 40 hours, collect their paychecks and enjoy their free time.

So it’s not easy being the boss.  That’s why so few people want to be the boss.  For it’s easier being an employee.  You work.  You get paid.  And you leave work at work.  Even if you think you’re not being paid as much as you deserve to be.  Something most employees feel.  That they’re overworked.  And underpaid.  But they never look at things through their employer’s eyes.  And see what they really cost their boss.

Most Businesses have gone from a Defined Benefit Pension Plan to a Defined Contribution 401(k)

What an employee gets paid and what an employer pays for that employee are two different things.  To begin with an employer pays for more hours of an employee’s time than he or she actually works.  When you factor in vacation time, holidays and sick days an employer may pay for 2,080 hours while the employee only works 1,896 hours.  If an employee makes $35 an hour those nonworking hours can add up to $6,440.  Which an employee gets for doing nothing.  We call them fringe benefits.  Just an employer’s way of saying, “Hey, I don’t hate you.  Here’s some money for doing nothing.”

Why do they pay this?  Because of free market capitalism.  If they don’t pay it someone else may.  And attract their good workers away from them.  Because if there is something employees will do is jump ship the moment they get a better offer.  Which is a good thing.  This is supply and demand.  And despite workers feeling overworked and underpaid this free market dynamic makes sure employees get paid as much as they can while helping employers pay as little as they can.  That equilibrium point where employees will keep working.  While leaving employers still competitive.  Though that’s getting harder and harder to do these days.  As the cost of doing business has never been higher.

In addition to these fringe benefits there are also health insurance, life insurance and retirement contributions.  With health care often being the greatest single employee cost to a small business owner.  Which is why most now make employees pay a small portion of their health care these days.  Retirement contributions have also gotten very costly.  Few people still have a defined benefit pension plan these days.  Typically an owner will offer a defined contribution 401(k) for the employee to contribute to.  And if times are good the employer may match their contribution up to a certain amount.  But employers will call this a discretionary contribution.  And it will be one of the first things to go when they are having cash flow problems in a bad economy.

The Last Thing a Business Owner needs while trying to Deal with Soaring Labor Costs are more Costs and Taxes

In addition to fringe benefits there are payroll taxes and insurances.  Such as Social Security.  Which the employer and employee split.  At least in theory.  The employer currently pays 6.2% on the first $110,100 in an employee’s earnings.  The employee kicks in 4.2% (which may go up another 2 points after the fiscal cliff, as that tax cut expires).  In reality the employee doesn’t pay any of this.  They get their check and go on their way while the employer has to find the cash to pay the 10.4% due.  For an employee earning $66,360 that Social Security tax payable comes to $7,571.  Another big check the owner has to write is for state unemployment.  Which can be anywhere around $4,000.  The following chart summarizes these and additional labor costs (note: the retirement contribution is probably between a 401(k) matching contribution and a defined benefit pension contribution).

An employee with a pay rate of $35/hour will gross $66,360.  Deductions will lower actual take-home pay.  But the employer’s total cost for this employee in this example is $108,252.  Or an additional $41,892 than the employee grosses.  Which comes out to another $17.04 an hour.  Something the employee never sees.  This is why labor is so costly.  And why employers want to hire as few people as possible.  For each additional employee they hire (in this example) they have to pay an additional 22.2% in payroll taxes/insurances.  And an additional 41% in fringe benefits.  Or a combined 63.1%.  In addition to what they’re paying the employees for their actual work.

And this is why employers want to offload health care (especially for their retirees).  And their pension liabilities.  As they can add an additional 30% (or more) to their labor costs.  What started out as fringe benefits to attract some of the best workers is now bankrupting many companies.  People are living so long into their retirement that these cost are growing faster and larger than any other cost a business has.  And it’s also why small business owners are very worried about new regulations and taxes.  For the last thing they need while trying to deal with these soaring labor costs are more costs.  Or taxes.  Which doesn’t make them cheap or greedy.  It just makes them very cautious business owners who are trying to keep their businesses afloat in an ever more difficult business environment.

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If it weren’t for High Labor and Regulatory Costs there would be no need for Currency Manipulation

Posted by PITHOCRATES - October 2nd, 2011

Minimum Wage Earners only become Valuable after Costly on the Job Training

Minimum wage jobs are entry level jobs.  And they’re starting to get that in the UK (see Minimum wage harming job opportunities for young by Richard Tyler and James Kirkup posted 10/2/2011 on The Telegraph).

Firms may be reluctant to create jobs by recruiting inexperienced staff because they are put off by the increased wage bill, the Low Pay Commission has suggested.

The Commission’s intervention comes amid calls from businesses for minsters to freeze or even cut the rate to enable more young people to find work…

Official figures last month showed that almost 1 million of the 2.5 million people officially counted as unemployed in Britain are aged between 16 and 24.

Almost 220,000 have been out of work for more than a year and some economists fear a “lost generation” of young people who never learn the habits of work and face a lifelong struggle ever to find employment…

“The concern is that the current rate is discouraging some employees from taking on young people and giving them a chance to get into the workplace,” he said. “Some companies are finding the rate is a real problem.”

The New England Patriots pay Tom Brady more money than the Detroit Lions pay Mathew Stafford.  Stafford was the number one draft pick.  Brady wasn’t.  But Brady has 3 Super Bowl rings.  Stafford doesn’t have one.  Yet.  He may have one soon, though.  He’s having a very good season.  Undefeated through 4 weeks.  But Brady is better.  Because of his 3 Super Bowl rings.  And his experience.  It’s that experience that makes him worth more.

What’s true for quarterbacks in the NFL is true for workers everywhere.  Experience makes a worker worth more to an employer.  Inexperienced workers are worth less.  So they’re paid less.  Just like in the NFL.

The New England Patriots pay Brady a lot of money.  But they can’t pay everyone that amount of money.  Most players will make less than him.  Just like in the workforce.

Key employees are paid more.  And less critical employees are paid less.  Entry level workers with the least skill and the least experience get paid the least.  These are the minimum wage workers.  Who are just starting their working careers.  Most of who are grateful for the work experience.   Because they know if they show ability they can move up.  Gain more experience.  And earn more as they become more valuable to their employer.  Or to their employer’s competitor.

So of course employers oppose high minimum wages.  Because minimum wage earners only become valuable after costly on the job training.  That’s why they’re paid the least.  They come in with nothing.  And don’t provide any value until the employer gives them value through training.  Mentorship.  And experience.

If you Protect your Markets too much from Imports you will Hurt your own Export Markets

Costs are costs.  And labor costs are some of the more expensive costs.  Because there are a lot of other costs attached to wages.  They add up.  And often are a percentage of an employee’s wages.  The higher the wage, the higher these other costs.  Which makes it harder for a business to be competitive.  And in today’s competitive global economy, nations will help their businesses be competitive any way they can.  To try and make up for all those onerous regulations they impose on their businesses (see One more such victory posted 10/1/2011 on The Economist).

A YEAR ago Brazil’s finance minister, Guido Mantega, declared that the world had entered into a “currency war”. He worried that in a depressed global economy, without enough spending to go around, countries would sally forth and grab a bit of extra demand for themselves by weakening their currencies. The dollar, for example, fell by 11% against Brazil’s real in the year to August 2011, much to the chagrin of Brazil’s manufacturers. Like other emerging economies it fought back by imposing taxes and other restrictions on foreign purchases of local securities…

A cheaper real, zloty and rupee will help emerging economies win a bigger share of global spending. But that is small consolation if global spending declines…

Falling export orders was one of the complaints voiced by Chinese manufacturers in a preliminary survey of purchasing managers published by HSBC last week.

Yes, a cheaper currency gives you an advantage.  So a nation wants it.  But so do other nations.  And what’s more, these other nations don’t want your nation to have a cheap currency.  Because a cheap currency means more exports.

But a currency war is a double edged sword.  If you protect your markets too much from imports you will hurt your own export markets.  Yeah, you may succeed in having a cheap currency but little good that will do if your primary export market slaps a punitive tariff on everything you sell there.

And then there’s the danger of releasing the inflation genie from its bottle.  If you devalue your currency too much your own manufacturing costs will rise.  It’ll take more dollars to buy the stuff you need to manufacture the things you sell.  Which means you’ll have to raise prices.  And anyone who buys from you will have to raise their prices.  And so on until this inflation ends in a recession.  Which will slash overall consumer spending.  Making any win in a currency war a hollow one.

The Senate Bill to Punish China for Currency Manipulation is nothing more than Pandering to a Recession-Weary America

So rational thinking bets against any currency war.  Or antagonizing any trade relationships.  Of course, in an election cycle, rational takes a back seat to winning an election (see Senators court 2012 voters with China currency bill by Doug Palmer posted 10/2/2011 on Reuters).

For lawmakers eyeing their re-election prospects next year, this week provides a chance to show they mean business about cracking down on China’s currency practices and returning jobs to America…

“It is very easy to say that China is the bogeyman,” said Doug Guthrie, dean of business at George Washington University. He said the bill would do little to help U.S. jobs and would raise U.S. import costs, but said it might yet pass…

The Senate bill is the wrong approach because most of the goods the United States imports from China are no longer made by U.S. industry, Frisbie [president of the U.S.-China Business Council] said.

“I’ve always been of the view that, if the Chinese currency were to appreciate, we’re not going to get those jobs back in the U.S. They will migrate to Indonesia or Vietnam or Bangladesh perhaps Sub-Saharan African — the lowest next lowest cost place,” Lardy [a senior fellow at the Peterson Institute for International Economics] said.

So this Senate bill is nothing more than pandering to a recession-weary America.  It won’t help the economy.  And probably will end up making things worse.  By making life that much more expensive for the American consumer.  By replacing those cheap Chinese goods with almost as cheap goods from Indonesia, Vietnam, Bangladesh or Sub-Saharan Africa.  All the while creating zero American jobs.   It will just make life more difficult.  But it may elect a politician or two.  And really, now, isn’t that what’s really important?  I’m jesting, of course.

Why Exactly is the ‘Made in USA’ Stamped Stuff more Expensive?

Perhaps it isn’t the Chinese.  Or the other emerging economies.  Perhaps it isn’t the weak currencies of our trading partners.  Maybe it’s us.  I mean, why do we play with the currency in the first place?  To make our goods cheaper.

So the issue we should be addressing is why are our goods more expensive in the first place.  Why exactly is the ‘Made in USA’ stamped stuff more expensive?  Higher labor and regulatory costs.  Such as the minimum wage.  And the hundreds of other costly regulations American businesses have to comply with.  Remove these and America can be competitive again.  With anyone.  Anywhere.  And in any industry.

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