Stephen Dubner has a post on the “Freakonomics” blog titled “The next time someone tells you that taxes are not progressive…” He relays information from a new Congressional Budget Office (CBO) report, via Greg Mankiw, which lists effective federal tax rates for households at various points in the income distribution. The rates are higher for those with larger incomes. The implication is that our tax system is quite progressive.
But it doesn’t make much sense to look only at federal taxes. State and local taxes account for about a third of total tax revenues, and they tend to be less progressive than federal taxes.
If we take into account all taxes — federal, state, and local — the effective tax rate for the well-to-do is only a bit higher than for the poor. Here is one way to see this, based on data from the CBO and the Tax Foundation.
January 5, 2009 at 4:14 pm
It is also interesting that when certain Serious Economists or Right Thinking Experts argue about cutting taxes, they always argue first about cutting capital gains, then corporate and income taxes, and I have not seen one Serious Economist or Right Thinking Experts advocate cutting sales or payroll taxes.
January 5, 2009 at 7:13 pm
Lane, can you break it down more finely? Things can be very different when you break out the top 20th percentile, looking at the top 5%, 1%, 0.1%.
January 5, 2009 at 7:58 pm
Richard,
I wish I could, but the Tax Foundation data on tax payments are only for the five quintiles.
Lane
January 5, 2009 at 11:37 pm
I think the percentage paid by the very wealthiest groups, top 5%, 1%, 0.1% would probably go down, with greater access to tax shelters and deductions, and with the capped and non-progressive pay-roll tax going to zero as a percentage of earnings.
Plus, capital gains taxes are much less than income taxes. EPI’s The State of Working America 2006/2007 has on page 79 a table showing that the top 1%, in 2006, got 33.2% of it’s income from capital income, 20.4% from business income, 11.1% from “other income”, and only 35.3% from wage and salary.
Look at what Justin Wolfers had to say in a May 1st post:
Do the well-off pay their fair share, or do they also deserve a tax break?
January 6, 2009 at 8:48 am
At the website ourfuture.org there is an article “A Final Report Card on the Reagan Years?”. The short story is the top .01 percent of taxpayers have an income of $412 billion (11,000 households making over $8.6 million) versus the bottom 20 percent with an income of $385 billion (24 million households with income below $17,000). A person with $10 million dollars isn’t any happier than a person with $9 million dollars. Kit
January 6, 2009 at 12:38 pm
Lane,
I would love to see a similar analysis to the one Mankiw provides that incorporates state and local tax rates, but it is very difficult to actually to see this in the graph.
Do you have a more clear depiction of the total effective tax rates for each quintile? Breaking it down into tax payments and pretax income kind of loses the issue in the margins. Percentages would be more powerful.
Also, CBO used total taxes by total income, would that be the same for this graph?
January 6, 2009 at 4:20 pm
Another way to look at it is Figure 3 from the Tax Foundation document you cite. If you include federal and state taxes, the system is still progressive, but notably less so.
Federal, State and Local Effective Tax Rates, Calendar Year 2004
By Income Quintiles
1: 13%
2: 23%
3: 28%
4: 31%
5: 35%
January 6, 2009 at 9:15 pm
Steve, thank you. Those numbers appear to be the proper counterparts to the Mankiw numbers.
For comparison:
Federal / Federal/State/Local rates
Lowest quintile: 4.3 percent / 13%
Second quintile: 9.9 percent / 23%
Middle quintile: 14.2 percent / 28%
Fourth quintile: 17.4 percent / 31%
Percentiles 81-90: 20.3 percent / (Fifth quintile mean: 35%)
Percentiles 91-95: 22.4 percent/ (Fifth quintile mean: 35%)
Percentiles 96-99: 25.7 percent/ (Fifth quintile mean: 35%)
Percentiles 99.0-99.5: 29.7 percent/ (Fifth quintile mean: 35%)
Percentiles 99.5-99.9: 31.2 percent/ (Fifth quintile mean: 35%)
Percentiles 99.9-99.99: 32.1 percent/ (Fifth quintile mean: 35%)
Top 0.01 Percentile: 31.5 percent/ (Fifth quintile mean: 35%)
I am presuming that the numbers would start off lower than 35% for the smaller percentiles Mankiw slices up for the fifth quintile, and end near if not higher than 40% for the top .01 percentile.
I suppose we can only speculate there.
But great numbers nonetheless!
January 7, 2009 at 12:04 am
Steve and Publius,
Actually, the Tax Foundation calculations of effective rates that Steve cites aren’t directly comparable to the CBO ones, because the Tax Foundation adjusts the incomes of each quintile for the estimated cost of transfers (see Appendix B of the working paper at http://www.taxfoundation.org/publications/show/2282.html if you’re interested in the details). Using Tax Foundation numbers comparable to those of the CBO (but including state and local taxes), the effective tax rates for the five quintiles in 2004 are:
Q1: 12.4% (bottom quintile)
Q2: 21.0%
Q3: 24.9%
Q4: 27.2%
Q5: 29.4% (top quintile)
But note also that both the CBO and Tax Foundation include government transfers in the incomes used to calculate effective tax rates. There’s nothing illegitimate about this per se; but if we want to see how much redistribution is accomplished via taxes vs. via transfers, it’s better to use only market (pretax and pretransfer) income in calculating the effective tax rates. Doing that with the Tax Foundation data yields the following effective rates:
Q1: 31.6% (bottom quintile)
Q2: 28.1%
Q3: 28.3%
Q4: 28.9%
Q5: 30.1%
Lane