Recent Trends in the Progressivity of the Federal Individual Income Tax

Three years ago, I authored a report indicating that by one measure, the progressivity of the federal 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. increased from 2000 to 2004 when one also considers the expansion of refundable 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. credits that are administered via the federal individual income tax. However, new data available indicates that my conclusion needs to be partially amended. This post is to clarify that report given both new data that is now available for 2000 to 2004 as well as new data from the IRS for tax years 2005-2007.

The table below shows how one measure of progressivity has changed from 2000 to 2007 using the new IRS data supplemented with data on refundable tax credits. My proxy of tax progressivity is tax share divided by income share. Under a perfectly proportional system, one’s tax share would always equal one’s income share; and thereby this ratio would be 1. Under a progressive taxA progressive tax is one where the average tax burden increases with income. High-income families pay a disproportionate share of the tax burden, while low- and middle-income taxpayers shoulder a relatively small tax burden. structure, however, that ratio will vary based upon income level. So high-income taxpayers will have a higher ratio than low-income taxpayers.

Comparing this ratio over time is not a perfect measure of changes in tax progressivity because not all of the change is policy-induced. That’s because changes in the components of income (such as greater capital gains income relative to wages) can also affect progressivity, even holding policy constant. However, this measure does provide some indication as to how changes in tax policy in 2001 and 2003 have affected the income tax’s progressivity from 2000-2007.

The total tax share for each group equals the amount it paid in federal individual income taxes divided by the total amount of individual income taxes paid by tax returns with a positive AGI. I also subtract from the total individual income tax amount the Additional Child 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. and the outlay portion of EITC, both of which were changed by the 2001 tax cuts.

Ratio of Tax Share to Income Share for High-Income Tax Returns

	Top 0.1%	> .01% thru 1%	> 1% thru 2%	> 2% thru 3%	> 3% thru 4%	> 4% thru 5%	> 5% thru 10%
2000	1.857	1.857	1.543	1.334	1.247	1.172	1.047
2001	2.067	1.972	1.579	1.381	1.286	1.221	1.091
2002	2.311	2.132	1.673	1.453	1.352	1.284	1.125
2003	2.208	2.155	1.712	1.466	1.350	1.273	1.095
2004	2.038	2.107	1.739	1.483	1.337	1.255	1.084
2005	1.925	2.030	1.727	1.477	1.325	1.221	1.058
2006	1.851	1.990	1.713	1.452	1.317	1.224	1.061
2007	1.796	1.969	1.710	1.449	1.298	1.218	1.059

Source: Authors’ calculations of IRS data. For year 2000, figures were estimated using both IRS percentile data and the 2000 IRS Public Use File.

As one can see from the numbers, when looking at the top 1 percent as a whole, it’s easy to see why one could conclude that the progressivity has increased. However, within the top 1 percent, progressivity has declined significantly. As one can see, the ratio of tax share to income share for top 0.1 percent of tax returns rose dramatically following the implementation of the first two tax cuts combined with the significant decline in capital gains and dividends income (capital gains of which were taxed at preferential rates at the time). But from 2002-2003, when the economy was once again on a growth path and a year that saw the passage of the 2003 tax cuts that cut capital gains and dividend taxes, the ratio of tax share to income share began to dip; eventually leading the ratio to be lower in 2007 than it was in 2000. For the rest of the top 5 percent, however, the tax share to income share ratio still remains higher in 2007 than it was in 2000. However, for these groups, like the top 0.1 percent, the ratio is lower compared to 2003.

And that leads me to this general conclusion: It appears that the progressivity of the federal individual income tax was increased by the 2001 tax cuts but reduced by the 2003 tax cuts. It’s difficult to determine the magnitude of the policy changes given the economic changes simultaneously occurring, but I’m pretty confident with the direction of both. Taken in their entirety, the tax cuts appear to have increased the progressivity of the federal individual income tax, except for those at the very, very top who have a significant fraction of their income in capital gains and dividends.

(One final note: Obviously the federal individual income tax is not the only tax, and a true measure of progressivity should take into account not only all taxes but the effects of government spending, especially given the symmetry between many targeted tax credits and government transfers. Such is the purpose of the Tax Foundation’s Fiscal Incidence project.)

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