Tax Withholding: Good For Government, Bad For Taxpayers

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Tax Withholding: Good For Government, Bad For Taxpayers

Most people don’t think twice about today’s tax withholding system, but taxes haven’t always been withheld at the source, and there are solid arguments against it. In general, tax withholding benefits the government while harming taxpayers.

Key Takeaways

  • Most full-time workers in the United States are acquainted with the tax withholding system, in which a percentage of a pay period’s gross income is withheld for tax reasons.
  • The advantages of this method include ensuring employees have enough money to pay their taxes, making it more difficult to cheat taxes, and providing the government with a regular stream of cash.
  • Overpayment of taxes creates opportunity costs for employees, as does fostering a disconnect or indifference between job income and taxes, which may drive unrestrained government expenditure.

Benefits of the Tax Withholding System

The tax withholding system was put in place to assist the government generate funds for several wars and to make it simpler for the government to raise taxes without people rebelling. Here are a few of the advantages of collecting taxes at the source – and keep in mind that the majority of these advantages favor the government rather than the taxpayers.

People don’t notice the missing money

People prefer to concentrate on their take-home salary, which makes reasonable given that it is the only money they have to work with. When they do look at the tax withheld, it may not seem to be a big sum since it is spread out across the 24 or so paychecks most individuals get each year. Because most people never touch all of their earnings and only see a number for the total amount of federal tax they’ve paid once a year on their tax returns (which don’t show how much they’ve also paid for Social Security and Medicare, or how much their employers have contributed to Social Security and Medicare on their behalf), the government can collect taxes more easily under a withholding system, even at relatively high rates.

There’s no need to save up for or make a gigantic payment in April

It is true that some individuals are terrible savers and would be unable to pay their tax payments in a single amount or even in quarterly installments. When confronted with a credit card debt today or a tax due in nine months, Americans who live paycheck to paycheck are likely to prioritize their immediate needs. As a result, tax withholding is believed to be easy for taxpayers since it enables them to make tiny, seem to be reasonable payments throughout the year. Some may argue that the government is being paternalistic by deciding when and how you will pay your taxes rather than allowing you to do it yourself.

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Withholding decreases evasion and underpayment

Because of the aforementioned savings conundrum, withholding increases the likelihood that the government will obtain the full amount of taxes owed. Withholding also makes it more difficult for taxpayers to keep their money out of the hands of the IRS.

Withholding decreases collection costs

Because most individuals have their employers send all or most of their taxes to the government, the IRS theoretically has a smaller pool of persons to go after for unpaid or underpaid taxes. This implies that less of your tax money will be required to pay the IRS’s collection activities.

Government uses the money sooner & steadily throughout the year

If this is genuinely a justification for withholding, it seems that the government is acknowledging that its own staff aren’t very adept at controlling program budgets. If they were, it wouldn’t matter whether programs were financed in a big amount in April or with regular payments throughout the year.


To choose the amount of tax withheld from their paychecks, employees must fill out IRS Form W-4, which is normally provided by their employer.

Criticisms of the Tax Withholding System

Most of us take the tax withholding system for granted, but concerned people, legislators, and economists who have studied it have numerous complaints of the system.

Taxpayers have no idea how much they pay and are apathetic about tax rates

If taxpayers had to make a single huge payment, they would know precisely how much they were paying in federal, Social Security, Medicare, and state taxes. Because the money is taken gradually, many individuals do not pay attention to the total amount, making it easier for high tax rates to endure and for the government to raise tax rates. The state of California, for example, chose in 2009 to exploit the tax withholding system to get a massive, interest-free loan from its taxpayers. It raised the withholding tax by 10%, and even journalists didn’t appear to notice until just before the rate rise went into effect. The administration promises to repay the borrowed funds in April.

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Taxpayer apathy contributes to high levels of government spending

As we all know, the government has a penchant for not only spending every every dollar collected, but also for running massive budget deficits. To extend on the preceding point, opponents contend that if taxpayers are unaware of how much of their income is going to the government, they are unlikely to establish the link between their income and the funds required to support new government programs and expand current ones. As a result, people are more inclined to support ever-larger programs without realizing that they are also supporting more taxes.

Taxpayers think that tax refunds are gifts from the government

They are unaware that the money has been theirs all along and that they have been making an interest-free loan to the government for the whole year.

Taxpayers don’t use their refund money wisely

A tax refund is not a windfall; it is money that you earned and should have had access to throughout the year. However, when money comes in the form of a big amount in the form of a tax return, it seems to be a nice reason to do some additional shopping. You may change your withholding so that you don’t get a hefty refund. You may utilize the additional money in each paycheck to help you accomplish your annual savings objectives.

Withholding causes opportunity costs for taxpayers. An opportunity cost is a lost opportunity, and if you’ve already “spent” any of your income on future taxes, you won’t be able to utilize it for consumption today. Taxpayers, for example, miss out on the interest they might earn on their tax payments if they could keep the money until April. This loss of interest builds up over the course of a year, let alone a lifetime.

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Taxpayers can’t protest by refusing to pay taxes

Citizens who wish to withhold their support for certain categories (or all sorts) of government expenditure or who feel the income tax is illegal may struggle to retain their money from the government under the tax withholding system.

The system penalizes wage earners

Because no taxes are withheld on investment or self-employment income (as well as a few other less prevalent sources of income), the withholding system is said to punish wage workers, or those whose taxes are collected at the source (from each paycheck).They must pay up sooner, which increases their opportunity costs from the withholding system.

The system imposes costs on employers

Employers who challenged tax withholding in 1913 and had it repealed in 1917 made valid concerns that remain valid today. Operations must engage more personnel to deal with tax withholding, and they must spend time and money on tax compliance that might be spent on expanding their businesses or paying their employees more.

The Bottom Line

It’s critical to understand where and why your paycheck money goes; after all, you earned it, and someone else decides what happens to it. Instead than seeing the tax system as a straightforward method to pay your taxes, understand what it really means for your money.

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