"Who's FICA, and why's he getting all my money?" Jennifer Aniston famously quipped as Rachel Green in an early episode of Friends. She isn't the first or the last to express this sentiment.

No one enjoys the exercise of examining their paystub to see how much money is being withheld, especially when it comes to state and federal income taxes. But a study from Villanova University has shown just why those withholdings, specifically at the state level, are so important to public tax coffers around the country.

I recently spoke to one of the authors of this study, Sutirtha Bagchi, an Assistant Professor of Economics at Villanova University's School of Business. He told me that state income tax withholdings are a relatively new phenomenon that have only been around for about 70 years and there hasn't been much research into how effectively they help states raise revenues.

"When it comes to withholding at the federal level, that was started around World War II, but when it comes to the state level, they did not all embrace it at the same time," he explained. "So what my co-author and I wanted to explore was exactly what the impact was of this introduction of withholding that happened from 1948-1976 at the state level on income tax collections, and the kinds of revenues that are being raised by state governments as a result."

The findings are astounding. The study revealed that the introduction of state withholding led to immediate increases of between 25 and 30 percent in taxes collected without any change in tax rates.

"If you just look at the year prior to the states adopting withholding, on average, income tax revenues were 15 percent of all tax revenues," Bagchi explained. "The next year, that number had grown to 20 percent of all revenues. That's a sudden and a major change that you just don't see when it comes to these numbers."

With that increase, the share of the income tax in total state tax revenue increased by about 19 percent.

So it's clear that state level withholding has made a massive impact on the efficiency of tax collection, helping compliance rates for income tax soar.

Of course, increased tax collection is never a popular topic among Americans, and leads to the obvious question: Is this rise in efficiency creating an unnecessarily large burden from the government on the average taxpayer?

"I don't think that's true, because one of the things that we notice is that in the years leading up to withholding, we see increases in state debt, but that seems to stabilize in the period after withholding," he explained. "So it's reasonable to say states didn't introduce withholding at random: there was a need for it."

It's hard to dispute that citizens benefit from a balanced budget, and ensuring compliance with state withholding seems to get most states closer to that goal. And there's a convenience factor too. States could instead send taxpayers a bill for every individual service they provide. Think tax season is bad now? Imagine having to pay a pothole-repair bill every month.

So the next time you go over your paystub and see how far your gross pay has been adjusted to your take-home amount, take heart that it's probably the lesser of all evils, even if it doesn't feel like it.

Published on: Aug 2, 2017
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