Progressive vs. regressive: How payroll tax structure differs from income tax

For early founders, payroll might seem straightforward. After all, gross pay minus taxes and payroll deductions involve simple arithmetic. In reality, payroll and income tax lines don’t always behave the way the formula suggests. 

Once you’re running payroll for more than a couple of people, the process could start to feel more complicated. For instance, maybe one of your senior hires had their Social Security withholding stop mid-year. Or your 401(k) matching costs keep climbing for one employee, while flattening out for another. All of these people are on the same payroll run, but their tax calculations are clearly different. That’s because income tax and payroll tax are built on different structures. 

This article will help you understand how to compare progressive tax vs. regressive tax, and why those differences matter for your team and budget.

For any founder comparing progressive vs. regressive taxes, it’s important to consider what happens to each employee’s tax rate as their income goes up:

• Progressive taxes: With progressive taxes, people with higher income pay a higher percentage of their income in taxes (aka tax rate) than people with lower income. That means an employee’s tax rate will increase as their income rises.
• Regressive taxes: With regressive taxes, the tax rate is the same for everyone, regardless of income level. That means that lower earners end up paying a larger percentage of their income than higher earners do. (Sales tax is a classic example of a regressive tax: A flat 7% tax on a $1,000 laptop costs every customer the same $70. But that $70 represents a bigger slice of a $40,000 income than a $150,000 one.)

Most taxes cost high earners more in dollars. What distinguishes regressive vs. progressive tax is the percentage of an employee’s income the tax represents.

Federal income tax is an example of a progressive tax. The IRS splits everyone’s income into bands, called brackets, and taxes each bracket at a higher rate than the last, currently running from 10% at the low end to 37% at the top. Because of how tax brackets operate, a worker earning $40,000, for instance, will pay a lower effective rate (the total share of tax they’ll pay) than a worker with a $400,000 salary. The bracket structure — plus tax credits and deductions aimed at lower- and middle-income households — means federal income taxes are progressive taxes. 

Sometimes people assume that landing in a higher tax bracket means that all of their income will be taxed at that same rate, but that’s a misconception. Only the income inside a given band is taxed at that band’s rate. The taxes a worker pays on their highest dollar of their income is called the marginal tax rate. For example, say a single filer earns $60,000 in taxable income. The first chunk will be taxed at 10%, which is the lowest bracket. The next chunk will be taxed at 12%, and only the portion above the 22% threshold will be taxed at the marginal rate of 22%. 

That’s why a raise never “bumps someone into a higher tax bracket” and leaves them worse off, the way some employees might fear. Only the new income above the bracket threshold is taxed at the higher rate. So, a raise always leaves employees with more money after taxes than they had before getting a raise.

So, you might be wondering, “Is payroll tax progressive or regressive?” The short answer is that this type of tax is considered to be regressive, even though the rate is flat.

A flat rate might sound neutral — and the Medicare portion of payroll tax basically is. But the Social Security portion, however, stops applying after a certain wage level, so payroll tax is generally considered to be regressive. (More on Medicare and Social Security payroll taxes below.)

How to calculate payroll taxes

Employer payroll tax and income tax work in completely different ways. The main federal payroll taxes are collected under the Federal Insurance Contributions Act (FICA), and they fund Social Security and Medicare. Unlike income tax, they’re based on a flat percentage from the very first dollar paid, with no brackets and no graduated rates. 

Here’s the breakdown: 

• Social Security: For this tax, the employee pays 6.2% and the employer also pays 6.2%, for 12.4% total. This rate structure is fixed, with a $184,500 wage cap. So, once an employee’s wages surpass that amount, you’ll both stop needing to pay this tax for the year.
• Medicare: For this tax, the employee pays 1.45% and the employer also pays 1.45%, for 2.9% total. This rate is also fixed, but there’s no wage cap.

Add the employee’s side together and that equals 7.65% that’ll get withheld from wages. As the employer, you’ll match this amount and also pay 7.65% in payroll taxes. 

One more layer also sits at the top: Wages above $200,000 carry an Additional Medicare Tax of 0.9%, which gets withheld only from the employee’s paycheck, with no employer match.

As noted above, Social Security tax only applies up to an annual cap ($184,500), called the taxable wage base. Below that ceiling, all employees pay the same fixed 6.2% tax rate. That’s why payroll taxes are considered to be regressive taxes. Once an employee’s income reaches that cap, that person stops paying Social Security taxes for the rest of the year. In other words, someone who earns more than the annual cap of $184,500 will only pay the 6.2% tax up to that amount.

This means that a higher earner will end up paying a smaller percentage of their income into Social Security — a regressive result that comes entirely from the cap. Only about 6% of workers earn above the cap in a given year, but for them, the savings can be significant.

Payroll taxes without wage caps

Medicare is an excellent example of how payroll taxes work when there’s no wage cap in place. In the case of Medicare taxes, the 1.45% tax rate applies to every dollar of wages. The rate never stops and never changes proportionally, so everyone pays the same share of taxes, regardless of their income. If anything, the 0.9% Additional Medicare Tax on wages above $200,000 nudges it slightly into the progressive category for the top level of earners. That’s the opposite of what the Social Security cap does. 

Here’s what payroll looks like for employees across three different wage levels, based on 2026 tax rates. Note: These examples are pre-income tax.

As this example shows, the flat rates might make payroll tax look like it’s evenly distributed across taxpayers, but the cap means lower and middle earners pay a higher combined percentage of their income than the highest earners do. 

As an employer, your matching obligation follows the same rules as the employee’s. You’ll pay 6.2% in Social Security up to the wage cap, 1.45% in Medicare with no ceiling, and you never have to match the Additional Medicare Tax (since that’s the employee’s responsibility). 

If you have a workforce with high earners, your Social Security match per person will stop growing once each employee crosses the cap. So, it’s worth building that into your budget at the beginning of the year. (Note: The wage base resets every January. For instance, it rose from $176,100 in 2025 to $184,500 in 2026. These changes will impact your withholding and matching for any employees near the cap.)

Have payroll tax questions coming in from staff members? If an employee is confused by their paystub, you’ll almost always find the answer embedded in one of these two concepts:

• Income tax is progressive by bracket, so withholding rises in steps, but never all at once.
• Payroll tax is flat but capped, so it holds steady until Social Security drops off at the cap.

If you’re doing your payroll taxes manually, there’s a lot to keep track of. You’ll have to switch Social Security off at the right dollar for each employee, make sure to adjust the wage base every January, and set up the Additional Medicare Tax at $200,000. If you forget to do one of these steps, you’ll either over-withhold, which will probably frustrate your team, or under-withhold, which can mean you’ll get hit with penalties at filing time. 

But using payroll software to help you manage your payroll taxes can ease these issues. Plus, payroll automations can handle the math. Good tools apply the current brackets and caps automatically, and they’ll adjust when the numbers reset. Automating that work will leave you free to think about headcount and compensation — and not get bogged down with managing withholding mechanics.

Ready to streamline your payroll? Walk through the full step-by-step guide to doing payroll or jump straight into how to set up payroll on Mercury.