payroll tax

payroll tax, levy imposed on wages and salaries. In contrast to income taxes, payroll taxes do not include income from capital sources such as dividends and interest.

Taxes on payrolls are seldom used as a source of general revenues, although in some developing countries the income tax base may actually include little beyond wages and salaries, the equivalent of the payroll tax base. Many countries do, however, levy payroll taxes to finance social security benefits, which include retirement and survivors’ benefits, disability insurance, and health care.

Payroll taxes have become an extremely important source of revenue, especially in countries with aging populations that will place increasing demands on social security systems. Because of international differences in both social security programs and the extent of reliance on general revenues, however, payroll tax systems and rates vary widely between countries.

Payroll taxes are virtually always collected through withholding, and they are often levied on both the employer and the employee. Unlike income taxes, payroll taxes usually make no allowance for the personal circumstances of the taxpayer, and, rather than being levied at graduated rates, payroll taxes often do not apply to income above a ceiling. It is therefore likely to be a regressive tax, both because of the ceiling on taxable payrolls and because labour income represents a declining fraction of total income as income rises. This effect, however, may be more than offset by the distribution of social security benefits, the majority of which are commonly allocated to the poor.