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Average Federal Tax Rates by Income Quintile

Summary:
A number of friends on Facebook have been discussing whether the federal tax system is "progressive." That word has emotive content--"progressive" seems good--but all it means is that the higher your income, the higher your tax rate. One economist friend argued that bringing in the Social Security tax (FICA) and the Medicare tax (HI) makes the system less progressive than otherwise. That's absolutely true for Social Security. The tax rate for Social Security is a flat 12.4% (6.2% for employer and employee each) for earnings up to 7,200 and zero thereafter. (In 2018, the threshold will be 8,400.) It's probably true for Medicare. One factor makes the Medicare (HI) tax a regressive tax and one factor

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A number of friends on Facebook have been discussing whether the federal tax system is "progressive." That word has emotive content--"progressive" seems good--but all it means is that the higher your income, the higher your tax rate.

One economist friend argued that bringing in the Social Security tax (FICA) and the Medicare tax (HI) makes the system less progressive than otherwise. That's absolutely true for Social Security. The tax rate for Social Security is a flat 12.4% (6.2% for employer and employee each) for earnings up to $127,200 and zero thereafter. (In 2018, the threshold will be $128,400.) It's probably true for Medicare. One factor makes the Medicare (HI) tax a regressive tax and one factor makes it progressive. I don't know which dominates. The factor that makes it regressive is that the tax is just on earnings and higher-income people have a higher percent of their income that is not classified as earnings--dividends, interest, rents, royalties, and capital gains, to name five. The factor that makes it progressive is that Obamacare added 0.9 percentage point to the HI tax for individuals making more than $200,000 and for married couples filing jointly making more than $250,000.

The net effect of all federal taxes is that the higher your income, the higher your average tax rate. (The CBO produced the graph below--see its Figure 4 on page 11.)

Average Federal Tax Rates by Income Quintile

Of course, we can't simply look at whom the tax is imposed on to know who bears the burden. It is a virtual certainty, for example, that some of the corporate income tax burden is borne by workers. This means, of course, that the cut in corporate income tax will help workers. We use the term "tax incidence" to describe who bears the burden of a particular tax.

In the study from which the figure above is taken, here's the CBO's explanation of how it allocated tax incidence. As it makes clear, these are assumptions. They may not be true.

CBO allocated individual income taxes and the employee's share of payroll taxes to the households paying those taxes directly. The agency also allocated the employer's share of payroll taxes to employees because employers appear to pass on their share of payroll taxes to employees by paying lower wages than they would otherwise pay. Therefore, CBO also added the employer's share of payroll taxes to households' earnings when calculating before-tax income.

CBO allocated excise taxes to households according to their consumption of taxed goods and services (such as gasoline, tobacco, and alcohol). Excise taxes on intermediate goods, which are paid by businesses, were attributed to households in proportion to their overall consumption. CBO assumed that each household's spending on taxed goods and services was the same as that reported in the Bureau of Labor Statistics' Consumer Expenditure Survey for a household with comparable income and other characteristics.

Far less consensus exists about how to allocate corporate income taxes (and taxes on capital income generally). In this analysis, CBO allocated 75 percent of corporate income taxes to owners of capital in proportion to their income from interest, dividends, rents, and adjusted capital gains; the adjustment smooths out large year-to-year variations in actual realized gains by scaling them to an estimate of their long-term historical level given the size of the economy and the tax rate that applies to them. CBO allocated the remaining 25 percent of corporate income taxes to workers in proportion to their labor income.


My gut feel is that the allocation of 25 percent of corporate income taxes to workers is too low. But it's only a gut feel.


David Henderson

David Henderson is a British economist. He was the Head of the Economics and Statistics Department at the OECD in 1984–1992. Before that he worked as an academic economist in Britain, first at Oxford (Fellow of Lincoln College) and later at University College London (Professor of Economics, 1975–1983); as a British civil servant (first as an Economic Advisor in HM Treasury, and later as Chief Economist in the Ministry of Aviation); and as a staff member of the World Bank (1969–1975). In 1985 he gave the BBC Reith Lectures, which were published in the book Innocence and Design: The Influence of Economic Ideas on Policy (Blackwell, 1986).

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