Countdown to Tax Reform, Part IV: Life Cycle and Income Inequality

October 20, 2005

Fiscal Fact No. 35

One of the more overlooked explanations for the difference in incomes between taxpayers is the issue of life cycle. In our younger years, we typically work part-time, low-income jobs as we complete high school or college. In our 20s, we begin our formal careers with our first full-time position. By the time we reach our 30s and 40s, we are well into the swing of our careers as we advance up the job ladder of our chosen fields. By the time we are ready to retire, we’ve reached the peak of our earning potential. When we do retire, we circle back to the bottom of the income scale living on a fixed income.

Tax Foundation economists used our matched IRS/Census database to calculate the median age of taxpayers within each income group. In the event that a tax return represented two or more wage earners, we included only the age of the primary earner.

Figure 1 shows that higher-income taxpayers are 50 percent older than their low-income neighbors. Overall, the lowest-income taxpayers (those in the bottom 10 percent) have a median age of 31 years. Looking at the remaining income groups reveals the progression of taxpayers’ incomes as they age in the workforce. Taxpayers in the middle 10 percent group have a median age of 40, while those in the top 10 percent have a median age of 47.

Figure 1. Age Explains a Large Portion of Income Differences Between Taxpayers

Source: IRS, Tax Foundation Individual Tax Model.

Table 1 shows in greater detail the age composition of each income quintile. The lowest income groups are overwhelmingly populated by younger taxpayers, while the upper income groups are overwhelmingly populated by much older taxpayers.

Table 1. Wealthier Taxpayers Tend to be Older Taxpayers

Age
Income Group 18 – 24 25 – 34 35 – 44 45 – 54 55 – 64 65 +

Bottom 20%

30.6%

19.2%

16.0%

11.2%

8%

15%

Second 20%

15.9%

25.0%

21.8%

14.0%

9%

15%

Third 20%

6.1%

24.5%

27.1%

20.2%

10%

12%

Fourth 20%

1.6%

19.5%

29.6%

25.6%

13%

11%

Top 20%

0.6%

12.6%

29.6%

34.3%

14%

9%

Subtotal

12.5%

20.6%

24.1%

19.8%

10%

13%

Source: IRS, Tax Foundation Individual Tax Model.

For example, fully 31 percent of taxpayers within the bottom income group are younger than age 24—the years in which most workers have yet to set upon a career. Indeed, more than 50 percent of these low-income taxpayers are younger than age 34 and early in their careers, while 15 percent are older than age 65 and are likely retired.

By contrast, nearly half (49 percent) of taxpayers in the top income group are clustered in the pre-retirement ages of 45 to 64—the years in which most workers reach their peak earnings—while only 13.3 percent are younger than age 34. It is likely that most of these young, upper-income taxpayers are the primary earner of a dual-income tax return with a joint income more than $71,000. For example, an entry level computer programmer earning $40,000 married to an elementary school teacher earning $35,000 have a dual income large enough to be in the top 20 percent of taxpayers.

These figures indicate that the life cycle of American workers is a contributing factor causing the income inequality that appears to exist among taxpayers when a one-year snapshot such as a distribution table is used. As workers get older, they earn more income and will naturally be wealthier than younger taxpayers who have scarcely begun their careers.

These findings also have very important policy implications. It means that reductions in the highest marginal tax rates will disproportionately benefit older taxpayers who are preparing for retirement, providing them more disposable income for retirement savings.

(This “Fiscal Fact” is based on the forthcoming Tax Foundation book Putting a Face on America’s Tax Returns. For more information please contact Bill Ahern at (202) 464-5101).


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