Last week, the Congressional Budget Office (CBO)The Congressional Budget Office (CBO) provides nonpartisan analysis to the U.S. Congress on federal economic and budgetary matters. published an updated analysis of the distribution of American households’ income and 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. burdens for 2017. The new CBO data reinforces existing trends in household income and tax burdens, showing that the federal tax system is progressive and incomes continued to rise in 2017 as part of the broader economic expansion post-Great RecessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. .
While this is data from before enactment of the Tax Cuts and Jobs Act (TCJA)The Tax Cuts and Jobs Act in 2017 overhauled the federal tax code by reforming individual and business taxes. It was pro-growth reform, significantly lowering marginal tax rates and cost of capital. We estimated it reduced federal revenue by .47 trillion over 10 years before accounting for economic growth. , it can still inform us about the nature of American household income and tax burdens across the distribution.
Income growth after taxes and transfers continued upward in 2017 when compared to the three previous years. Since 1979, average incomes in the lowest quintile increased by 86 percent, while average incomes for the middle three quintiles grew by about 50 percent over that time. The highest quintile’s income after taxes and transfers rose by 111 percent since 1979. The CBO data shows that labor income is the major income sources for most taxpayers, while business and investment income is a more important income source for higher earners.
Overall, the federal tax system was progressive in 2017, applying higher effective rates going up the income spectrum. The effective federal tax rate rises from 1.3 percent for the bottom quintile to 31.6 percent for the top one percent.
The federal tax code has become more progressive over time. The effective federal tax rate for the bottom quintile averaged about 10.6 percent in the 1980s but has remained below 3 percent since 2007. In contrast, the effective federal tax rate for the top one percent has remained relatively high over this period, ranging between 25 and 35 percent since 1979.
Average federal tax rates vary by revenue source. For example, 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 are highly progressive, providing a negative effective tax rate for those in the bottom 20 percent due to 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. s such as the Earned Income Tax Credit (EITC)The Earned Income Tax Credit (EITC) is a refundable tax credit targeted at low-income working families. The credit offsets tax liability, the total amount of tax debt owed by an individual, corporation, or other entity to a taxing authority like the Internal Revenue Service (IRS), and can even generate a refund, with earned income credit amounts calculated on the basis of income and number of children. and the Child Tax Credit (CTC)The federal child tax credit (CTC) is a partially refundable credit that allows low- and moderate-income families to reduce their tax liability dollar-for-dollar by up to ,000 for each qualifying child. The credit phases out depending on the modified adjusted gross income amounts for single filers or joint filers. . These credits provide refunds to filers who do not have tax liability to offset, creating a negative effective income tax rate. In fact, the lowest quintile’s average federal tax rate was -10.9 percent in 2017. In contrast, those in the top 20 percent paid an effective 16.6 percent income tax rate.
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, on the other hand, tend to be more evenly applied, though somewhat regressive, ranging from 9.4 percent for those in the lowest quintile to 6.5 percent for those in the top 20 percent. 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 are regressive, as those in the lower quintiles pay higher effective rates than higher earners.
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 are borne across the income distribution, but effective rates are slightly higher for higher earners, who tend to own more corporate equities than those who earn less.
Reflecting the increasing progressivity of the federal tax code, the share of federal taxes paid by high earners has increased in recent decades. The top one percent paid 25.3 percent of all federal taxes in 2017, up from an average of 14.3 percent in the 1980s.
By contrast, the share of federal taxes paid by the bottom 60 percent fell from an average of 22.3 percent in the 1980s to 13.1 percent in 2017.
The progressive nature of the federal tax system combined with transfers to low-income Americans creates a wedge between income shares before and after transfers and taxes (see Chart 5). In 2017, Americans in the highest income quintile saw a decrease in their income share from 38.5 percent to 35.1 percent; those in the lowest quintile saw an increase in their income share from 3.7 percent to 7.5 percent, largely due to refundable 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. s and other means-tested transfers.
This data shows how the federal tax system and other means-tested transfers change the distribution of household income. Contrary to the perceptions of some, the data indicate that (1) income earned after taxes and transfers has increased over the past several decades for all income groups; (2) the federal tax system is increasingly progressive; and (3) that system relies heavily on higher earners to raise revenue for government services and means-tested transfers. These facts should be kept in mind when considering policy proposals that would increase tax burdens or reshape the distribution of existing taxation.
Stay informed on the tax policies impacting you.
Subscribe to get insights from our trusted experts delivered straight to your inbox.Subscribe