Surprising Answers to Three Tax Questions

Posted by: Michael Mandel on April 18

I’m just going to make this short and simple. We hear all this spin about how the tax system is fair/unfair to the rich/middle-class/poor. In honor of April 15, I figured that I would just present the numbers, and let you draw the conclusions.

I should say, though, that the results surprised me. Feel free to offer your comments (all numbers come from the latest tax report from the Congressional Budget Office).

Question 1: Is the federal tax system progressive? (that is, does it impose substantially higher tax rates on the rich)

Answer 1: Yes.

The latest year available from the CBO is 2004, which includes all the Bush tax cuts. In that year, the effective federal tax rate paid by the top 1% of people was 31.1%, compared to 13.9% for the middle quintile, or fifth, of people, and 4.5% for the lowest fifth.

Effective Federal Tax Rate, 2004*
Federal taxes as percent of income
Top 1% 31.1
Top 5% 28.5
Top 10% 26.9
Highest Quintile 25.1
Fourth Quintile 17.2
Middle Quintile 13.9
Second Quintile 10.0
Lowest Quintile 4.5
*Includes income taxes, social insurance taxes
excise taxes, and corporate income taxes
Data: Congressional Budget Office

Question 2: Has the federal tax system gotten less progressive over the past two decades?

Answer 2: Surprisingly, the answer is no, according to the CBO data. Let’s compare 1981, the last year before the Reagan tax cuts, and 2004, the first year after the Bush tax cuts. In 1981, the effective tax rate on the top 1% was 31.8%, compared to 31.1% in 2004. That’s hardly a difference. By comparison, the effective tax rate on the bottom fifth dropped from 8.3% to 4.5%.

In other words, the people at the bottom saw their effective tax rate decline more than the people at the top. Incidentally, this calculation includes Social Security taxes.

texttaxprogressive_4142_image001.gif

Question 3: The middle class has been hit by higher federal taxes.

Answer 3: No. The effective federal tax rate for the middle quintile has fallen over time, from 19.2% in 1981 to 13.9% in 2004 (this leaves out state and local taxes, of course). It’s worth noting that the middle quintile tax rate fell more under the Republicans than the Democrats.

texttaxprogressive_2135_image001.gif

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Reader Comments

Brandon W

April 18, 2007 04:29 PM

I think the tax-rate issue is dead. The Republicans can't really cut anymore and the Democrats don't really have the numbers to back their claims of unfair middle class taxation (as per your reported numbers). The issue now is where the money is being spent, and what do we cut in order to stop deficit spending and pay down the national debt? How do we fix the tax system to be simpler and eliminate the AMT? I don't believe either party has compelling answers to these questions.

highb8a

April 19, 2007 12:02 AM

I have a question regarding AMT.

But for the lack of indexing, could AMT be the sought after flat tax? I was wondering if it would make sense to dilly dally till it catches pretty much everyone and then just index the numbers to inflation.

Jim Haggerty

April 19, 2007 10:33 AM

Mike,

This is an interesting analysis and would be a great article for BusinessWeek. Any chance you will flesh it out and write an article. I'm sure it would be controversial....

Nelson Chung

April 19, 2007 12:50 PM

greatest reduction is in the lowest quintile, a 44% reduction in the rate. I think that's because Clinton cut taxes on the poor, and then W. cut them again.

Lord

April 19, 2007 12:51 PM

Marginal rates are an important consideration, but one really has to consider what is considered taxable income as well. The affluent have a much greater means of deferring taxation and avoiding it altogether if the estate tax was eliminated.

Mike Mandel

April 19, 2007 01:37 PM

Lord..good point. I have to check whether these numbers include the estate tax.

Mike Mandel

April 19, 2007 01:37 PM

Nelson...the reduction at the bottom was pretty surprising, especially since the social security and medicare taxes went up over this period.

Brandon--I don't think the tax rate issue is going away so soon.

Kartik

April 19, 2007 04:03 PM

I have always wondered : why not ust do away with the 10% and 15% brackets altogether? They only contribute about 5% of federal tax revenues, but would be the best way to relieve taxes on the poor, the unemployed, grad students, etc.

I think it would supercharge the economy if the first $40K to $60K were not taxed at all by eliminating those lower two brackets. Not just in tax savings, but in the tens of millions of returns that could just take an 'EZ' form and slash filing and processing resources consumed.

Politically, who the hell would be foolish enough to oppose THAT tax cut?

Kartik

April 19, 2007 04:20 PM

I agree that the AMT is a blessing in disguise, right under everyone's noses.

We should eliminate the current tax code, index the AMT for WAGES, and just use the AMT (at the 26% rate). It is MUCH simpler and will save us the time/processing/auditing burden that currently costs the economy $400 to $600 Billion a year.

That is the magical flax tax + simplification that everyone wants

Samantha

April 20, 2007 08:50 AM

The question still is why are we cutting taxes when we do have such a deficit? We are spending all this money, but where is it coming from? Also, in past "war" times the American public has had to pay higher taxes, make concessions, but what have we been asked to do since soldiers have been in Iraq? I think that these are some of the bigger questions that we need to all be thinking of... lower taxes and higher spending does not balance a budget.

Dan Olson

April 26, 2007 01:32 PM

This is a great topic. Thanks for raising the issue. But can someone clarify what the CBO means by "Effective Tax Rate?" These numbers don't correspond with the actual tax rates published by the IRS so I'm just trying to figure out the difference to get a better handle on the implications.

Thanks.

http://www.irs.gov/pub/irs-soi/histaba.pdf

Joe Cushing

May 7, 2007 11:08 AM

Does this include the portion of social security "paid" by the employer? I'm sure it wouldn't change much but it's just a thought.

Dan

Effective tax rate is simply your tax divided by your income. This rate is an average rate as apposed to your marginal rate which is the tax on the next dollar you earn. The marginal rate is generally quite a bit higher. The effective rate takes into account all the lower rates you pay on the bottom portion of your income.

Mike Mandel

May 7, 2007 02:43 PM

The employer share of Social Security is in there.

Joe is right about the effective tax, with one addition. The CBO actually adjusts income for family size. Here is the full text:


"Income categories are defined by ranking all people by their comprehensive household income adjusted for household size--that is, divided by the square root of the household's size. (A household consists of the people who share a housing unit, regardless of their relationships.) Quintiles, or fifths, of the income distribution contain equal numbers of people.

Comprehensive household income equals pretax cash income plus income from other sources. Pretax cash income is the sum of wages, salaries, self-employment income, rents, taxable and nontaxable interest, dividends, realized capital gains, cash transfer payments, and retirement benefits plus taxes paid by businesses (corporate income taxes and the employer's share of Social Security, Medicare, and federal unemployment insurance payroll taxes) and employee contributions to 401(k) retirement plans. Other sources of income include all in-kind benefits (Medicare, Medicaid, employer paid health insurance premiums, food stamps, school lunches and breakfasts, housing assistance, and energy assistance). Households with negative income are excluded from the lowest income category but are included in the totals.


"

Rockfest

June 5, 2007 02:34 PM

The article is misleading. For instance the REAL test of progressively in the federal tax system would be the effective income tax rate for the upper income earners... not just the total tax rate for ALL taxes including regressive payroll taxes.

Lets look at the CBO’s Appendix 1-A… Effective Individual Income Tax Rate for the top 1% of income earners. We get a different picture than the author's.

Of ALL the years in the CBO study... 1979 to 2004, only FOUR years have had a lower effective income tax rate than 2004. ALL those years were after Reagan’s irresponsible 1981 ERTA tax cuts. The rates are also down 4.6% from 2000 levels.

This seems like pretty solid evidence that at least one of the author's conclusions was designed more to mislead than to enlighten.

FY79 21.8%

FY80 22.3

FY81 21.5

FY82 20.4

FY83 19.4

FY84 19.3

FY85 18.9

FY86 18.3

FY87 21.5

FY88 20.7

FY89 19.9

FY90 19.9

FY91 20.6

FY92 21.2

FY93 23.2

FY94 23.0

FY95 23.7

FY96 24.2

FY97 23.8

FY98 23.4

FY99 24.0

FY00 24.2

FY01 24.1

FY02 23.7

FY03 20.4

FY04 19.6

Mike Mandel

June 6, 2007 01:50 PM

Why would that be the real test? I would think we would want to add in all taxes.

gmb92

June 29, 2007 02:02 PM

I'm not sure where the author is getting his numbers from but they're not correct.

Start with Table 2 (total effective federal tax rates). The appropriate column is 2004, which the author also is quoting. 2005 and later assumed the expiration of many of the tax cuts enacted earlier.

http://www.cbo.gov/ftpdoc.cfm?index=5746&type=0&sequence=1

Lowest quintile: 5.2% (a drop of 0.2 percentage points since 2001)

Upper quintile: 23.8%

Top 1%: 26.7% (a drop of 6.3 percentage points since 2001)

An analysis of the tax system is incomplete without including regressive state taxes, which includes sales and property taxes. The lowest quintile on average pays about 12% of their income in state taxes vs about 6% for the upper incomes. This closes the gap considerably.

Figure 5:

http://gatton.uky.edu/CBER/Downloads/hoyt00.htm

I'm not sure if this analysis includes regressive things like vehicle fees and it certainly doesn't include lottery revenues, which in an economics sense is a regressive (albeit voluntary) tax.

The super-wealthy, who's income is mostly passive (investment), pay a much lower tax rate. Long-term capital gains and dividend rates are currently 15%. Warren Buffet's effective tax rate is about 17-18%.

http://business.timesonline.co.uk/tol/business/money/tax/article1996735.ece

Makes you wonder how the "top 1%" effective rate is calculated.

PSI

September 16, 2008 01:13 AM

Brandon stated:
Brandon W
April 18, 2007
04:29 PM

"I think the tax-rate issue is dead. The Republicans can't really cut anymore and the Democrats don't really have the numbers to back their claims of unfair middle class taxation (as per your reported numbers). The issue now is where the money is being spent, and what do we cut in order to stop deficit spending and pay down the national debt? How do we fix the tax system to be simpler and eliminate the AMT? I don't believe either party has compelling answers to these questions"

Brandon, you're absolutely correct. that's how they want us to feel. helpless and impotent to make the changes that need to be done. changes are definitely something the wealty and upper crust want to maintain for themselves as lon as possible.

during my college studies, during ancient times, a seed was planted by an econ prof. that i had the pleasure to learn from.

1 of the taxation issues put on the table was, why do we tax corporations.of course many students said, oh yea, more taxs breaks for the wealthiest! by itself there thinking woul probably turn out correct. BUT.....BUT>>>

my plan is to create a National sales tax. only the final seller on the retail level would ultimately pay the tax.

it would relieve most businesses and manufacturers from having to pay taxes at all. the line of reasoning over the years has been that tax savings would be passed on to ht consumer>>>LOL on hte ground.

we all know that the greedy upper echelon would take that windfall and put into there pockets all the items they no longer pay taxes on.

this is where it gets interesting and combative. Let's say your factory job is now exempt from federal taxes. or state taxes. you are know in charge for every cent you make. your employer no longer has to pay taxes on your income and he/she has a lot of unexpected money.

in a pure economic system the employers who were benefiting would lower pricing in prportion to the windfall they would inherit under this system and some wopuld trickle down to the workers.

it's a wonderfull dream(fairytale) unless we the people, yes us the majority say enough is enough.

yes we do away with corporate taxes but in return corporations will be mandated by law to give every employee and every child in our country medical insurance, healthy meals.

this is just the beginning of what should be the next great American Revolution.

they say it won't work because it puts there power base at risk.

Email me at: pisrael10024@yaahoo.com
I am PSI >>> it came to me several months ago. i ignored it but it's become to srtong to ignore

Rise up middle class tax payers & send the message that change for us will only come if we insist/fight for it.

read your history, the Greeks the Romans and why they were toppled by the commom man who refused to be there slave.

come stand with me to make a world were you have a say>

PSI lives in all of us>>>
email peter@licgac.com to learn how you can change the system and benefit yourself

God Bless you: PSI

PSI

September 16, 2008 01:28 AM

Brandon stated:
Brandon W
April 18, 2007
04:29 PM

"I think the tax-rate issue is dead. The Republicans can't really cut anymore and the Democrats don't really have the numbers to back their claims of unfair middle class taxation (as per your reported numbers). The issue now is where the money is being spent, and what do we cut in order to stop deficit spending and pay down the national debt? How do we fix the tax system to be simpler and eliminate the AMT? I don't believe either party has compelling answers to these questions"

Brandon, you're absolutely correct. that's how they want us to feel. helpless and impotent to make the changes that need to be done. changes are definitely something the wealty and upper crust want to maintain for themselves as lon as possible.

during my college studies, during ancient times, a seed was planted by an econ prof. that i had the pleasure to learn from.

1 of the taxation issues put on the table was, why do we tax corporations.of course many students said, oh yea, more taxs breaks for the wealthiest! by itself there thinking woul probably turn out correct. BUT.....BUT>>>

my plan is to create a National sales tax. only the final seller on the retail level would ultimately pay the tax.

it would relieve most businesses and manufacturers from having to pay taxes at all. the line of reasoning over the years has been that tax savings would be passed on to ht consumer>>>LOL on hte ground.

we all know that the greedy upper echelon would take that windfall and put into there pockets all the items they no longer pay taxes on.

this is where it gets interesting and combative. Let's say your factory job is now exempt from federal taxes. or state taxes. you are know in charge for every cent you make. your employer no longer has to pay taxes on your income and he/she has a lot of unexpected money.

in a pure economic system the employers who were benefiting would lower pricing in prportion to the windfall they would inherit under this system and some wopuld trickle down to the workers.

it's a wonderfull dream(fairytale) unless we the people, yes us the majority say enough is enough.

yes we do away with corporate taxes but in return corporations will be mandated by law to give every employee and every child in our country medical insurance, healthy meals.

this is just the beginning of what should be the next great American Revolution.

they say it won't work because it puts there power base at risk.

Email me at: pisrael10024@yaahoo.com
I am PSI >>> it came to me several months ago. i ignored it but it's become to srtong to ignore

Rise up middle class tax payers & send the message that change for us will only come if we insist/fight for it.

read your history, the Greeks the Romans and why they were toppled by the commom man who refused to be there slave.

come stand with me to make a world were you have a say>

PSI lives in all of us>>>
email peter@licgac.com to learn how you can change the system and benefit yourself

May the Tax Gods Bless you: PSI

peter

January 31, 2009 12:46 AM

President elect Obama, shortly after being elected, stated that we needed to "think outside the box". How is a "Stimulus package "thinking outside the box"? He could have at least renamed it.

Thank you for your interest. This blog is no longer active.

 

About

Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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