There is a vigorous debate among the presidential candidates over how we should taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Americans at different income levels. Some candidates argue that wealthy families should pay more, while most candidates contend that the middle class is overtaxed. Still, others argue that everyone should get a tax cut.
What few of these candidates acknowledge is how progressive the current tax code really is. Recent data produced by Treasury’s Office of Tax Analysis shows that not only is the income tax very progressive, but so too is the overall tax system when we include payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. es, corporate income taxes, and various excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. es.
Treasury’s data for 2015 [found here] allows us to look at two simple ways of measuring the progressivity of the tax code: the share of the total tax burden borne by families at each level of income; and, the average tax rateThe average tax rate is the total tax paid divided by taxable income. While marginal tax rates show the amount of tax paid on the next dollar earned, average tax rates show the overall share of income paid in taxes. s paid by families at each level of income.
The Treasury data is comprehensive, in that it includes all roughly 167 million families (rather than just the 145 million income tax filers) and it uses a broader “cash” measure of income that includes government transfers in addition to wages, salaries, and investment income. Treasury divides the population into deciles, or ten equal groups of 16.7 million families.
Tax Burdens are Progressive
The first chart compares each group’s share of total income to the share of income taxes they pay, as well as all federal taxes paid by that income group. In a perfectly egalitarian or proportional tax system, the share of taxes that each group paid would match their share of the nation’s income. But as the chart clearly shows, families in the first eight deciles (10 through 80) pay a significantly smaller share of taxes compared to their share of total income. By contrast, families in the 90th decile, pay a considerably larger share of the tax burden—for both income taxes and all federal taxes—than their share of national income.
Looking specifically at income taxes, we can see that families below the 50th decile have a negative tax burden. In other words, the bottom half of all families receive more back from the IRS in cash (through refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit (EITC). s such as the Earned Income Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. (EITC) and the child credit) than they owe in income taxes. On the other hand, most of these families do pay other types of taxes (such as payroll taxes and some share of corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. es), but even their share of total federal taxes is well below their share of the nation’s income.
At the other end of the income spectrum, it is clear that families above the 90th percentile pay proportionately more in taxes compared to their share of the nation’s income. Collectively, these 16.7 million families earn 43.5 percent of the nation’s income, but pay 81 percent of all income taxes and 61.2 percent of all federal taxes.
At the top, the 1.5 million families in the 99 to 99.9 percentile group, earn 9 percent of the nation’s income and pay 21 percent of income taxes and 14 percent of all federal taxes. The wealthiest 0.1 percent of families (roughly 200,000 in number), earn 8.7 percent of the nation’s income, but pay nearly 24 percent of all income taxes and 16.5 percent of all federal taxes.
Average Tax Rates are Progressive
Next, we’ll compare average tax rates, which is the percentage of a family’s income that is paid in taxes after accounting for any credits or deductions. As the nearby chart shows, the average tax rates for both income taxes and all federal taxes are also very progressive, the poor have low average tax rates while the wealthy pay much higher average tax rates.
Focusing first on individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. es, we can see that families in the bottom half of the population have negative effective tax rates as a result of the cash they received from refundable tax credits. Families in the next tier of income, those in the upper-middle 50th to 90th deciles, do have positive average tax rates ranging from 2.2 percent to 9 percent.
At the upper income levels, we can see that average tax rates range from 11.4 percent for families in the 90th through 95th percentiles, to 25.7 percent for families in the top 0.1 percent.
The average tax rates for all federal taxes follow a similar progressive pattern, but with fewer families with negative effective tax rates. The bottom 20 percent of families still have negative effective tax rates even after accounting for additional federal taxes paid, such as payroll taxes, excise taxes, and some corporate income taxes. The broad middle-income groups have average tax rates ranging from the low single digits to roughly 21 percent for families in the 80th to 90th decile. For families in this group, payroll taxes take the second largest share of their income after income taxes.
By contrast, families in the 90th percentile and above have average tax rates ranging from 23.2 percent, to 39 percent for the top 0.1 percent of families. For many of these families, the extra tax burden comes from higher taxes on corporate income and from estate and gift taxA gift tax is a tax on the transfer of property by a living individual, without payment or a valuable exchange in return. The donor, not the recipient of the gift, is typically liable for the tax. es.
No matter how you look at it, America’s tax system is very progressive. High-income Americans pay a disproportionate share of the tax burden and, even after accounting for credits and deductions, they pay considerably higher average tax rates than other families.
Treasury’s latest data on tax burdens is a window into how difficult tax reform will be. To many, the goal of tax reform is to broaden the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. while lowering tax rates. Given the current progressivity of the system, such an exercise could result in higher taxes on the poor (who pay little or nothing) and lower taxes on the rich (who pay nearly everything). This is not the kind of platform most politicians want to run on.Share