- America's progressive tax system redistributes wealth: 70 percent of federal taxes are paid by the top 20 percent of earners.
- While 46 percent of Americans pay no federal income tax, most low-wage workers still pay other federal levies.
- Tax receipts are at lowest level since 1950: just over 15 percent of GDP.
When it comes to taxes, there are two points on which virtually every American agrees:
- They’re paying too much.
- Someone else is not paying enough.
Agreement ends the moment they start pointing fingers at that someone else. To some, it’s the half of Americans who pay no income tax. To others, it’s a billionaire who pays a lower rate than his secretary. Many contend Americans are overtaxed, while others claim the opposite.
Who’s right? Texas Enterprise consulted several University of Texas at Austin faculty, along with reams of tax data, to come up with this guide to Truth in Taxing.
Who’s Paying More Than Their Share?
It’s the rich. According to the nonpartisan Tax Policy Center, 70 percent of total federal taxes are paid by the top 20 percent of earners, whose cash incomes top $103,465 a year. They earn only 55 percent of the nation’s income.
The curve is even steeper among the much-discussed 1 percent, an exclusive club whose entry level is $2 million. They pull in 17 percent of the nation’s income and pay 26 percent of total federal taxes.
Do the Wealthy Pay a Fair Share?
Most tax policy commentators believe higher earners should pay higher tax rates, the keystone of a progressive tax system. “If you have a higher income, you have a greater ability to pay,” says Robert Peroni, professor at the School of Law. “It’s a theory of redistribution of wealth, no question about it.”
In a stricter economic sense, he cites the marginal utility of dollars. “The theory is that a rich person’s top dollars are worth less to them than the same dollars are to a low-income person. The lower-income person is spending most of their money on essentials, not discretionary purchases. The rich person is using it to buy a fancy car.”
Where commentators disagree is on how steeply taxes should tilt towards high incomes. Jim Nolen, distinguished senior lecturer in finance at the McCombs School of Business, notes that fancy cars are usually built by middle-income workers. When the nation tried a luxury tax, back in 1990, it was repealed after boat-builders lost 200,000 jobs. “It didn’t hurt the rich guy,” says Nolen. “He just deferred buying a plane or a boat. Rich people buy a lot of goods that lower and middle-class people make.”
Who’s Not Paying Taxes?
Very few Americans. It’s true that 46 percent pay no federal income tax. The TPC reports that the vast majority of those make under $30,000. Their taxable incomes are cancelled out by exemptions, deductions and credits, from the personal exemption to breaks aimed at the elderly or working poor with children.
But most low-wage workers still pay other federal levies: the payroll taxes that fund Social Security and Medicare. Those taxes hit only the first $110,100 of income, which means low earners pay bigger shares of their incomes than high earners. Those making under $50,000 pay 25 percent of total payroll taxes, on 21 percent of the nation’s income.
“It’s a canard that half the people don’t pay tax,” says Peroni. In theory, Uncle Sam keeps Social Security and Medicare monies separate from income tax receipts. But in reality, he has borrowed from both trust funds for decades to pay general expenses. “As a practical matter,” says Peroni, “the payroll tax goes in the kitty with everything else.”
But Nolen counts Social Security and Medicare as insurance contributions, not taxes. “Just because Congress is stealing from the cookie jar does not mean that these programs were meant to be a tax,” he says. “You’re buying insurance for your health care and for your retirement.”
It’s worth nothing that a small percentage of those who pay zero income tax are anything but poor. The TPC estimates that 425,000 have incomes over $100,000, including 4,000 who earn more than $1 million. They exploit a wide range of deductions and income exclusions, from mortgage interest on large homes to education expenses and tax-exempt interest, like that paid on municipal bonds.
Are Americans Over-Taxed?
Probably not, say Peroni, Nolen, and Lillian Mills, chair of the Department of Accounting at the McCombs School. A few ways to test this question:
Falling tax zone. Tax rates have dropped sharply over the past half-century. The Office of Management and Budget reports that over the past three years, federal tax receipts have run between 15.1 and 15.4 percent of gross domestic product. Those are the lowest percentages since 1950.
Rates for well-off taxpayers have dived the deepest. In the early 1960s, the top rate on income was 91 percent. Today, it’s 35 percent. Even if the 2001 Bush tax cuts expire at the end of this year, that rate will only bump up to 39.8 percent.
No sticker shock. Only a sucker pays sticker price on a new car. Likewise, most taxpayers pay rates that are far below the ones set by law.
Despite a top income tax rate of 35 percent, taxpayers who make more than $100,000 pay an effective rate of 25 percent, according to the Congressional Budget Office. Those in the middle of the income range, between $40,000 and $50,000, pay an effective rate of 14 percent, though their official tax bracket is 25 percent.
That’s due partly to a generous array of deductions and credits. Such “tax expenditures” — so-called because economists consider them a disguised form of government spending — saved taxpayers $1.1 trillion last year, according to the Joint Committee on Taxation.
It’s also because investments are taxed at lower rates than wages. Most capital gains and dividends are taxed at a maximum of 15 percent, which is how uber-investor Warren Buffet can pay a lower effective rate than his secretary. The economic justification is that people need bigger incentives to risk their capital than to work, Mills explains. “We don’t want to discourage the investment that is the engine of our economy.”
Low peer pressure. The 34 industrialized countries in the Organization for Economic Cooperation and Development use different mixes of taxes. But add them all together and America places 32nd. Its tax revenues are 24.1 percent of GDP, compared to an average of 33.8 percent.
“I expect that we’re a little under-taxed,” says Nolen. But he notes that other governments, such as Canada and Germany, spend more on social services than the U.S. “You would expect that in a system with more government control, people would be paying more in taxes.”
Ultimately, notes Mills, it’s a society’s choice as to how much taxation is too much. “I don’t think we’re overly taxed, compared to what we get, but people who think they’re too high must believe that they don’t want as much government service as they’re getting. That’s an ideological question as much as an economic one.”
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