Psychologically, it seems as if all money taken out of a person's paycheck is the same, but income and payroll taxes serve very different functions, with contrasting effects.
Income taxes are withheld from an employee's wages and go into a general fund. Payroll taxes are comprised of Medicare and Social Security taxes--also withheld from an employee's paycheck. However, the employer also pays payroll taxes to the federal government for these programs (in addition to the amount an employee pays).
Federal income tax and the Medicare tax have no limit, but the Social Security payroll tax always carries a cap. In 2008, Social Security tax topped out at 6.2 percent on an earnings maximum of $102,000.
People often simply lump all Social Security taxes together, when technically only taxes on an employer's payroll are considered payroll tax. As of 2010, employers only pay the "Old Age and Survivor’s Insurance" and "Federal Unemployment Tax Act" portion of Social Security.
Generally, income tax is considered a progressive tax--higher incomes are taxed at a greater percentage than lower incomes--and payroll tax is regressive—that is, it makes up a larger percentage of income as earnings fall.
The bottom 20 percent of U.S. wage earners in 2006 had their payroll tax outpace their income tax 99 percent of the time. In the same year, payroll tax outpaced income tax only 7.7 percent of the time for the top 20 percent of wage earners.
- Image by Flickr.com, courtesy of Abd Essamad