How is America's Income Tax Burden Weighted?
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
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
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.”
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.