The federal individual income tax may be progressive – it collects at much higher rates from higher income groups – but the collection patterns of other taxes are quite different.
The federal government’s single biggest tax, the individual income tax is a complicated function of each family’s income from wages, investments and other sources. It is the subject of much analysis of its fairness.
For example, the Congressional Budget Office found that, in 2005, the highest 10 percent of households in terms of income paid 16 percent of their income in federal income tax. The next 10 percent of households in terms of income paid 12 percent of their income.
At the same time, the bottom 40 percent of households in terms of income owed, on average, no tax, in the sense that those households received more in refundable income tax credits than they paid in tax.
That is the concept of progressive taxes — high-income households not only pay more tax but pay a greater fraction of their income in tax. It would seem, then, that taxes are something paid by people with above average incomes, without cutting noticeably into the purchasing power of people with lesser income.
Although the personal income tax is the federal government’s single biggest tax, most federal revenue, and most state and local government revenue, comes from a combination of other taxes.
Of these, the three largest are payroll taxes, sales taxes and property taxes, bringing a combined 12 percent of gross domestic product to public treasuries, as compared with 8 percent of G.D.P. collected by the federal income tax. (In order to abstract from the effects of the recession, and for reasons of data available, this post and next week’s focus on taxes as collected in the mid-2000s. How things may have changed since then can be seen here and here).
Sales taxes collected from retailers are an important revenue source at the state and local level, and are not significantly progressive even when they tax “necessity” and “luxury” items at special rates.
Payroll taxes are regressive, because the tax rate on the first $100,000 or so of earnings (this level has varied by year) is five times the tax rate on earnings above $100,000.
When interpreted as a tax on housing, the property tax is also somewhat regressive, because high-income people spend a lesser fraction of their income on housing, especially on the rental housing that is often subject to higher property tax rates than owner-occupied housing.
Corporate, estate and other taxes on capital may appear to hit wealthy taxpayers disproportionately, but I explained last week how that appearance is deceiving and inconsistent with the economics of capital taxation, which says that workers bear much of the burden of capital taxes in the former of lower employment and wages.
For this reason, I assume that capital taxes have essentially the same income incidence as sales taxes, although quantitatively results for the total tax burden would be pretty similar if I assumed (contrary to economic reasoning) that capital taxes are borne by who writes the checks to the government, because capital taxes don’t bring in much revenue.
The chart below shows the progressivity of taxes in 2005 by comparing income shares paid in taxes across income deciles. The bottom area shows the combined income shares of all federal, state and local taxes with the exception of the federal individual income tax. The shares paid in federal individual income tax are stacked on top of the bottom area, so that the sum of the two shows the shares of income paid in all taxes.
For example, the top decile (the 10 percent of households with the highest incomes) paid 15.5 percent of their income in the other taxes, 16 percent of their income in federal income tax and 31.5 percent of their income in all taxes combined.
The bottom decile paid 25.8 percent of their income in other taxes and -6.5 percent in federal individual income tax (that is, the tax paid them in the form of a refundable credit), for a combined total of 19.3 percent.
To derive these results, I used calculations from the Congressional Budget Office for the federal taxes, with the exception of the capital income taxes cited above. For the state and local taxes, I used the calculations of the late Joseph Pechman, published in 1985. Because of a lack of data, I excluded a significant amount of “miscellaneous receipts” by state and local governments (e.g., revenues from the state lottery), although I suspect they are regressive, too.
In the years since Professor Pechman made his calculations, the average state and local taxes have not experienced the kinds of changes that federal taxes did with the 1986 tax reform and with President George W. Bush’s tax cut, so I simply rescaled his calculations to reflect the minor changes in the share of G.D.P. obtained by state and local taxes.
Beginning with the blue series in the chart, we see that other taxes are regressive. The poorest decile pays the largest fraction of income in those taxes – more than 25 percent – while the highest income decile pays the smallest fraction of its income – less than 16 percent. (By definition, the high-income deciles have more income, so they pay more absolute dollars in tax even while their fractions are lower).
Especially noticeable is the dip from the 8th to the 10th decile, which occurs because much of the payroll tax is capped and does not apply to capital income, which is relatively more numerous in the higher deciles. (Note that the 9th and 10th decile are not the “quarter millionaires” that have received so much attention in recent tax debates; they would be only a minor fraction of the 10th decile. For a paper that looks at federal taxes for the top couple of percentiles, click here).
Total tax payments are the combination of other federal individual income taxes and the other taxes, and are mildly progressive. The fraction of income paid in all taxes (shown as the black line in the chart) tends to rise with income; it is about 20 percent for the lowest four deciles, about 25 percent for the middle two deciles and about 30 percent for the highest four deciles.
As noted above, the bottom deciles pay negative individual income tax, so for them the combined tax rate is actually less than the “other” tax rate.
Although low-income Americans pay little, if any, individual income tax, much of their income does go toward payroll, sales, property and other taxes. When all taxes are considered, most income groups pay taxes that amount to roughly 20 percent of their income.
Added: To calculate sales tax incidence for 2005, I scaled Pechman's 1985 estimates to reflect changes in the amount of revenue obtained by those taxes. However, the technology for sales tax avoidance has changed a lot over those years -- in particular, many people avoid sales tax by making purchases on the internet. To the extent that the internet intensity of a household's purchase patterns rises with its income, sales taxes in 2005 are even more regressive than I have assumed.