Taxes: Who Pays?
Last month, we took a first look at some of the tax change proposals from the administration’s budget. If we are going to get serious about tax reform, we had better understand the basics and not just the baloney sometimes printed in the press. So I thought that it may be a good idea this month, with Tax Day fresh in the rearview mirror, to examine just how much the federal government collects and from whom it collects it.
This past recession highlighted the cyclical nature of government revenues. Prior to the recession, which began in December 2007, the government’s tax take had risen to just under $2.6 trillion in FY 2007 but then fell dramatically, reaching a low of $2.1 trillion in 2009, before rising just a tiny bit in 2010. As a share of GDP, revenues declined from 18.5% in 2007 to just 14.9% in both 2009 and 2010, the lowest share since 1950. According to the Congressional Budget Office’s (CBO’s) Preliminary Analysis of the President’s Budget for 2012, revenues are projected to grow fairly steadily to almost $4.6 trillion (19.3% of GDP) by 2021.
The sources of federal revenue in order of magnitude are individual income taxes, social insurance (i.e., payroll) taxes, corporate income taxes, other taxes (such as estate and gift taxes, customs duties, and other fees and fines), and excise taxes.
Individual Income Taxes
Individual income taxes were a record $1.16 trillion in 2007 (8.4% of GDP), but they dropped the next year as the recession deepened and plunged to only $915 billion in 2009 (6.5% of GDP). Revenues from individual income taxes continued to drift down in 2010 to $898 billion, about 6.2% of GDP. With the recession officially ending in mid-2009 and the economy beginning to pick up steam and create more jobs and greater income, individual income taxes are expected to increase over the next few years.
There is a common misperception that the burden of the income tax is borne by the middle and lower classes and that the “rich” don’t pay their “fair” share. However, the tax distribution tables tell a much different story and show a highly progressive tax system.
According to the CBO report Average Federal Tax Rates in 2007 (the latest data available), the higher income groups have consistently paid a disproportionately large share of the tax bill. The data show that the top 1% of all households paid 39.5% of total federal income tax while earning 19.4% of total income in the economy. The top 20% paid 86% of total income taxes while earning 55.9% of total income. The next quintile paid 12.7% of income while earning 19.3% of total income.
In contrast, the middle quintile paid only 4.6% of federal income taxes in 2007 on an income share of 13.1%. The second lowest quintile paid a negative 0.3%, that is, they actually got money back from the government. Their income share was 8.4%. The lowest quintile also had a negative tax liability of 3% and an income share of 4%. Thus, it is easy to see that our current tax code is highly progressive, and that the higher income groups actually pay more than their “fair” share.
The CBO report also shows that the individual income tax—the largest source of federal revenues—has gotten sharply more progressive over the past 30 years. In fact, the CBO data show that since 1979, not only have the income tax shares of the lower four quintiles continued to drop, but the lowest quintile has been in the negative since 1987 and the second lowest has been in the negative since 2002. This means that the lowest 40% have no federal income tax liability and actually get subsidized by the government through refundable tax credits and other incentives.
To put this in perspective, we can look at effective tax rates. The effective rates on all federal taxes in 2007 were lower than in 2000 for all income groups. However, the biggest percentage drops occurred at the lower end of the income distribution. The average rate for the top quintile dropped by 10.4%, while the lowest quintile declined by 37.5%. The same trend holds if we look just at income taxes. The top quintile saw its effective income taxes drop by 17.7%, while the lowest quintile dropped 47.8%.
The data clearly indicate that, contrary to popular belief, high-income households not only pay the largest share of taxes, but they actually contribute a disproportionately large share compared with their share of income. Moreover, the relatively larger declines for the poor over the last few years mean that the tax code has become even more progressive since 2000.
Some uninformed people still claim that the tax code is not progressive when one adds in other types of taxes such as payroll and excise taxes. The data show that even when all taxes are included, the system is still very progressive. This is remarkable, considering the fact that these figures include Social Security taxes, which fall more heavily on the middle and lower income classes because a higher percentage of their wages are covered by payroll taxes.
The data show that the top 1% of all households paid 28.1% of total federal tax liabilities. Moreover, this percentage of taxes paid has grown consistently over the years. The top 20% paid 68.9% of total federal taxes. The next quintile paid 16.5%.
The middle quintile paid only 9.2% of federal taxes in 2007. This was a lower tax bite than they experienced in 2000 and has consistently declined since 1979. The second quintile paid 4.4%, while the lowest quintile paid only 0.8%. Although this is a bit more than their share of income taxes, the system is still very progressive.
Some people remain uninformed about the nature of corporate tax payments as well. First, it’s important to recognize that only people pay taxes and despite the fact that corporations send a check to the IRS, individuals actually bear the burden of corporate taxes. Exactly how this burden is shared remains a bit murky, but it’s generally accepted that corporate taxes may reduce wages for employees, increase costs for consumers, and provide a lower rate of return to shareholders.
Just as the recession lowered the government’s take from individuals, corporate income dropped from a record $370 billion in 2007 (2.7% of GDP) to $304 billion the next year. In 2009, revenues from corporate taxes fell to $138 billion. Revenues turned up again in 2010 to $191 billion and are projected to exceed historic norms over the next few years.
As for whether corporations pay their “fair” share, it is true that their share of total tax revenues dropped significantly during the recession. That’s to be expected, however, since many corporations had no profits during this time. As a percentage of federal revenues, corporate income taxes for 2006 and 2007 represented 14.7% and 14.4% of the total, respectively—the highest shares since 1978—and higher than at any time during the Clinton years. They dropped to only 6.6% in 2009 but have been trending up since.
Although the facts are clear, the general public seems blissfully ignorant of them. Moreover, the press and some members of Congress and the administration continue to misinform about and demagogue the issue. If we are going to have a reasoned debate about debt, deficits, and tax reform, then we owe it to ourselves to start with the facts.