Withholding prevents people from spending too much and being unable to afford their annual federal income tax bill. (You can’t spend what never hit your bank account in the first place!) It’s a helpful program that keeps people from falling behind on their taxes and then owing interest and penalties to the government.
The sheer practicality makes the program popular. (I participate!) But every year I wonder if withholding does more harm than good.
The psychological impact of withholding is the exact opposite of paying taxes. You don’t feel like something is being taken away from you. In fact, you probably feel like you’re getting money from the government when you get your tax refund every year. But that’s a deceptive feeling. It was your money to start with. Withholding is how that comfortable lie gets perpetuated.
Leave it to the government to devise a system that takes more than a fifth of your earnings and then tells you it’s giving you money.
All the money withheld from your paycheck throughout the year is an interest-free loan to the government. If it’s your money, shouldn’t you be the one earning interest on it? In theory, the IRS should calculate the interest earned on your withheld wages and apply it to your tax refund – but of course, the IRS doesn’t do that. It just takes the interest-free loan all the way to the literal bank.
Ending withholding would reframe our national conversation about income tax policy. Much is said about the wealthy “paying their fair share” – but 45% of American households pay no federal income tax. For many retirees, that makes sense – but this country is nowhere near 45% retired. Millions of people cannot possibly be “paying their fair share” because they’re not paying anything at all.
Americans are also woefully ignorant of how much tax we really pay. A recent survey found that 2/3 of people did not have a good mental estimate of their tax rate. If people knew what they paid, they’d be more inclined to care about what the government does with it. It’s impossible to think about ROI when you don’t know what you invested to begin with.
Seeing a sizeable chunk of your income get sent to the government once a year will have a much greater mental impact than seeing small amounts get siphoned off to the IRS every pay period. And yes, you’ll have to plan for an annual tax bill. But the “withholding” line on your paycheck could be replaced with a “save this amount” line, to save everyone some math and avoid catching people off guard come April.
The idea isn’t to send people into debt. The idea is to force everyone to plan for – and SEE – just how much the government takes from them each year. It’s time to treat one of our largest annual expense like that – a big cost, not an obscure line item baked into our paychecks.