How is America's Income Tax Burden Weighted?

Tax Tips

(alancleaver_2000)

Updated Mon., March 22, 2010.

One of the most contentious issues in politics and economics is how America’s income tax burden – who pays the most and least on a yearly basis – is weighted. Countless editorials and op-ed pieces make implicit assumptions one way or the other about who pays the most, but remarkably few include hard, factual data to support those assumptions. The lack of data in much of what passes for analysis of the tax burden is not because the data is unavailable or difficult to obtain. Rather, it appears that data is simply passed over in the rush to express preconceived opinions on the matter. Consequently, public opinion (and perhaps tax policy) is being shaped largely by insinuation, rather than by data. Ultimately, however, how our tax burden is weighted is not a moral or ethical question, but a factual question – and a most important one. Below, we’ll analyze data from the Tax Foundation in detail – who pays the most, who pays the least, and how the progressive nature of American income taxation shapes the outcome. The answers we uncover might surprise you, especially if it is the first time you have seen the information being analyzed.

Progressive Taxation & The Tax Burden

(kevindooley)

The first thing to understand about America’s income tax burden is the progressive nature of its income tax system. “Progressive” is meant here not in the normative sense of “better” but in the quantitative sense of “more.” Basically, America’s income tax system is set up so that individuals (or couples filing jointly) who earn higher yearly incomes will be taxed at a higher rate. Very simply, if you earn more, you pay more. Progressive taxation is codified by the Internal Revenue Code into “brackets”, within which people who earn certain incomes fall and are taxed. Bargaineering recently published an updated list of the marginal income tax brackets for 2010, which is reproduced below:

Contrary to what I originally reported, TurboTax Blog reader Clark A. Wise astutely pointed out in comments the full truth about what these brackets mean. As these are marginal tax rates, the rate in question applies to income above and beyond the stated amount. This means, for example, that if you earn $50,000 in a year, the first $8,375 of it would be taxed at 10%, while the next $25,625 gets taxed at 15% and the remaining $16,000 gets taxed at 25%.

Therefore, you owe $837.5 in tax on the $8,375, while you owe $3,843.75 on the $25,625 and owe $4,000 on the remaining $16,000. In total, if you took no deductions or credits, you owe $8,680 in total federal income taxes.  From here (as Clark noted below in comments) we can go further to calculate what is known is your effective tax rate. You get it by dividing your total income tax  by your total taxable income, which in this case equals .1736 (or about 17%.)

It may also be worth noting that the top marginal tax rate was once much higher than 38%. The Tax Policy Center has an easy-to-read chart of the top marginal tax rates in every year since the income tax was instituted in 1913. During that time, the top marginal rate has been as low as 7% (in 1913) and as high as 92% (from 1952-53.) It was 91% from 1954-63, and more recently, was 70% for the entire decade of the 1970’s. Regardless of the particular year or rate, however, the basic, underlying structure of American taxation was – and still is – progressive.

Who Pays More & Less

(Rob Lee)

It sounds like a relatively simple question: who pays more or less income taxes? That being said, we must careful to define what, exactly, we are trying to answer. The argument is often made that yes, higher income earners pay more in absolute terms (as shown above), but the poor and “middle class” (in whatever income range that is defined to be) pay more relative to their incomes. In other words, someone earning less money and paying, say, the 10% or 15% marginal tax rate misses that money more than someone earning more and paying  the 35% rate, because the latter person still has a lot left over. Of course, it is not clear that this is actually true. Presumably, someone earning several hundred thousand dollars a year has a vastly different lifestyle to support than someone making twenty or thirty, and it’s tough to imagine, even for them, a scenario where their taxed-away income is mere expendable excess. Several hundred thousand dollars could be the combined income of a married doctor and lawyer, each of whom only recently attained high incomes after years of repaying student loans and earning lower incomes in residence studies and internships. However, even if that argument is granted, the question of how the tax burden is weighted is not simply who misses their taxed-away income more. What we are ultimately attempting to answer is which group of people contributes most to the total amount of federal income taxes collected, in absolute terms.

That question is a lot simpler to answer. In fact, the TurboTax blog ran a post on how America pays taxes versus how other wealthy countries pay hints at the answer:

“A look at the data on tax distribution in the United States, for instance, reveals that high income individuals pay an enormously disproportionate amount of total income taxes in the country. The Tax Foundation’s Fiscal Facts report shows that the top 1% of income earners (1,410,710 people) pay 40.42% of all income taxes in the United States. The top 2.5% (5,642,839 people) pay 20.20% of total income taxes, while the top 5% (a combined 7,053,549 people) pay 60%. The top 10% as a whole pays 71.22%, while the bottom 50% of taxpayers account for only 2.89% of all income taxes.”

These numbers can be examined in even more depth. The 1,410,710 people who comprise the top 1% of income earners, for instance, earned $2,008,259 trillion – of which $450,926 billion went to federal income taxes. Overall, the Tax Foundation shows in this graph, the top 1% now pays more total income tax than the bottom 95%. The top 10% as a whole earned $4,227,839 trillion – of which $794,432 billion went to taxes. Of the $1,115,504 trillion of total income taxes collected, the top 10% paid nearly half. This data, updated in 2009, was calculated using income tax returns from 2007 and is the newest data available at time of writing.

It is important to keep in mind that the tax burden being weighted heavily toward high income earners is not a coincidence. Progressive taxation means that America’s income tax system is literally designed to produce such outcomes. Indeed, the Tax Foundation’s Scott Hodges cited, ”…an OECD study released last year showing that the U.S.—not France or Sweden—has the most progressive income tax system among OECD nations.”

The Takeaway

Contrary to general assumptions, low and middle income earners do not pay the bulk of federal income taxes in America. Because our income tax system is progressive, high income earners automatically pay a higher percentage of taxes on their already higher incomes. This has led to a scenario where the top 1% of income earners (and incoming earning couples) now pay more income taxes than the bottom 95% combined. While arguments can be made one way or the other about who should pay more or less, who does pay more or less is a subject about which there can be no confusion.

Comments (25) Leave your comment

  1. Regardless of hooch mich money you make, just because you are rich or make your money through capital gains, it is not fair that some people pay an effective rate of 13% of their income vs 35% of you income. And thats the point buffet was trying to make.

  2. this is not all that useful, since it is only about income taxes, not all taxes (payroll, sales tax, property tax, fees etc.). the wealthy pay way less a share of their income in overall taxes than lower income folks. the progressive nature of our income tax is to undo that, at least a little bit. And with all the loopholes, it barely makes a dent. The rich get away with paying so much less.

    1. Hi Craig,
      Thank you for your comment. We will take your feedback into consideration and blog about some other taxes that you mentioned.
      Feel free to always check our blog to find out about other current topics.
      Have a good day!
      Lisa Lewis

  3. An earlier post mentioned that Warren Buffet pays taxes at 13% but the he’s a billionaire. The IRS recently announced the top 400 taxpayers earned an average of $325 million and payed taxes at near capital gains rates of 16.6%. That’s why Warren Buffet said “It’s not fair that I should pay taxes at a lower rate than his secretary.”

  4. These tax rates also do not indicate the lower tax rate on capital gains. Middle and lower income folks typically receive less of this benefit because they either

    a/ do not have this type of income, or

    b/ the income is generated in tax deferred accounts.

  5. Actually, there is another non-trivial problem with Alan’s link – it relies on household wealth.

    Why is that a problem?

    Because households are not standard units. There are different numbers of people in different households. There are different numbers of *working* people in different households. Households vary from one income level to another, one age group to another, etc.

    For example, in 2000, the top 20% of households (by income) had 19 million heads of household working, while the bottom 20% of households had fewer than 8 million. Additionally, almost six times as many people in the top 20% of households worked full time as the number of people in the bottom 20%.

    In absolute terms, 3.9 heads of household worked full-time and year round in the top 5% of households, and just 3.3 million in the bottom 20%. No surprise there — more people working tends to equal more income.

    So, again, we ought to make sure we’re talking about real people rather than making apples to oranges comparisons of statistical categories.

  6. Alan,

    Definitely an interesting link. One thing I would add, though, is that statistical categories like “the top 1%” or “the bottom 50%” are not fixed groups of people. Rather they are transient categories into and out of which people go every year.

    Another issue is that your link did not count *all* the assets people possess, such as transfers in kind or government assistance. Quoting from Thomas Sowell’s Economic Facts and Fallacies:

    “Since people in the bottom 20% of income recipients receive more than two thirds of their income from transfer payments, leaving those cash payments out of the statistics greatly exaggerates their poverty – as does leaving out in-kind transfers such as subsidized housing.”

    In other words, only about 22-25% of the “actual economic assets at their disposal” are counted.

  7. I’m sorry to post once more, but after this article was updated, I realized that my graphic incorrectly listed the top tax bracket as 38% rather than the correct 35%. Here is the corrected version:

    [img]http://imgur.com/aT1Gn.png[/img]

  8. [img]http://www.joetaxpayer.com/images/2010taxrates.jpg[/img]

    Josh – I saw you updated your post a bit, but it’s not yet 100%.

    You suggest someone earning $375,651 (net taxable, of course) will pay $142,747 in tax. The chart I show above shows that a single person will only pay $108,421.

    I know your article was to make a point, but I’d still not overlook some detail in doing so. Single or marries both have a standard deduction and exemption. So for that single person, the first $9350 of income isn’t taxed at all.

    Last, you state the top 1.4M people earned $2,008,259 trillion. I think you meant million here. Forgive me, I’m a stickler for accuracy.

    Joe

  9. Hi there,

    Chelsea from TurboTax. Our writer Josh updated the post today, and responds to your comments Clark above: http://blog.turbotax.intuit.com/tax-tips/how-is-americas-income-tax-burden-weighted/

    I really appreciate the keen eye that you all have had in regard to the post, and your attention to these details has helped us make it better :)

    Athensguy, we take our product accuracy so seriously, we have a guarantee! No worries there.

    Thanks everyone,

    Chelsea

  10. athensguy,

    You shouldn’t be worried about the validity of the TurboTax software because of an error in one blog post. It is my understanding that many blog posts here are by guest contributors, where the authors are not associated with Intuit or Turbotax at all. The error probably slipped through only because one blog moderator missed it.

    I am quite confident that the software itself is reviewed very carefully by many experts and very thoroughly tested.

  11. I am a little worried with this blog posting. Primarily because of two things:

    1) I used Turbotax for my 2009 taxes

    2) The tax table is wrong

  12. “the top 1% now pays more total income tax than the bottom 95%”

    This illustrates how ridiculously huge the gap has become between the rich and the rest of us.

  13. Very intriguing information. Unfortunately, I believe your math is incorrect in the example of the high earner’s income tax. Thankfully, this error does not detract from the ultimate point of this article. However, it seems many people are still confused about how tax rates are calculated, so this deserves to be cleared up.

    “Marginal” means “in regard to the next one.” When someone’s marginal tax rate is 38%, this means that the next dollar they earn will be taxed at 38%. It does NOT mean that once they hit a certain threshold, every dollar they previously earned will be retroactively taxed at this new higher rate.

    The Wikipedia article on “Progressive tax” has a good example:

    “When implemented a progressive tax with increasing percentage rates, the percentage of tax of each dollar increases as the total revenue (or income) increases. For example, a tax of 15% on all income earned up to $50,000, plus a tax of 25% on each dollar earned between $50,001 and $100,000, plus a tax of 34% of all income earned above $100,000. The United States currently uses increasing percentage rates.”

    http://en.wikipedia.org/wiki/Progressive_tax#Increasing_percentage_rates

    There are six tax brackets in the U.S., as opposed to three in the above example. Thus, calculating your actual U.S. income taxes is slightly more complex, but the procedure is identical. Hopefully the attached graphic will help clarify the actual 2010 U.S. tax brackets.

    “Effective” means “actual, overall.” Once you calculate the total amount of income tax using the brackets as described above, the percentage of income tax you actually owe as compared to your total taxable income is your effective tax rate. For example, imagine my wages yield $15,000 of taxable income. I earned $6,625 more than $8,375 ($15,000 – $8,375 = $6,625), so my tax breakdown would be as follows:

    10% * $8,375 = $837.50

    15% * $6,625 = $993.75

    $837.50 + $993.75 = $1,831.25

    My total income tax is $1,831.25. Now we take the ratio of my total tax to my total taxable income.

    $1,831.25 / $15,000 = .122083, or about 12.21%

    Therefore, overall, my “effective tax rate” is 12.21%.

    [img]http://farm3.static.flickr.com/2687/4446908047_753377020b_o.png[/img]

    Disclaimer: I am not a tax professional. This is how I understand tax brackets, but if I am wrong I apologize for misleading and implore more qualified persons to note the necessary correction(s).

  14. i wonder wtf is going on then, i make 31k and get charged 33% … not including state/county/sales/etc taxes.

    i’ve never felt like got anything near my contributions back in gov’t services.

  15. The third richest man in the world,Warren Buffet, has publicly stated that he pays an effective tax rate of 13%. I don’t know why he would lie about something like that.

  16. What this fails to address is other kinds of taxes, like capital gains tax which is 5% for the bottom two tax brackets and 15% for everyone else. And since most of the super rich will be making most of their money from capital gains and not regular income their effective tax rate is much lower than that of someone making most of their money from income.

    Someone who earns $375,651 in income has an effective tax rate of 38%.

    Someone who earns $600,000,000 in capital gains and $375,651 in income (total: $600,375,651) has an effective tax rate of ~15.01%

    1. Your observation still does not change the fact that the top earners pay the majority of the overall income taxes collected by the government, regardless of what percentage it is of their overall income.

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