Monday, October 06, 2008

Facts matter: The super rich and middle class do not pay similar federal tax rates.

Local blogger and MATC instructor Michael Rosen suggests that we have an essentially flat federal tax system. In linking to a post that Rosen called "Cherry picking distorts Obama's tax proposals", WisOpinion titles it "Middle class and super rich pay similar federal tax rates."

This would be an interesting bit of news were it true. It is not.

Rosen relies on an article in the Los Angeles Times. That article but says it relies - without links or other specifics - on the Tax Policy Center. The Tax Policy Center, in turn, seems to rely on the Congressional Budget Office for effective federal tax rates. Let's go the the recent work of the CBO and see what that tells us.

In 2005, the top quintile consisted of households earning over $ 91,706. Contrary to Rosen's implication, taxpayers in that category pay an effective rate significantly higher than those with more modest incomes. With respect to incomes taxes, the effective rate for the top 20% was 13.9% compared to 5.9% for those in the fourth quintile ($57,661 to $91,705 in 2005) and $ 3.0 for those in the third 20% ($36,001 to $57,660 in 2005). (These numbers are different than the marginal rates because they are the average percentage of total income paid in federal income tax.) If we look at higher earners, the disparity gets larger - the effective federal income tax rate is 17.6% for the top 5% (average income of $457,400 in 2005) and 19.7 for the top 1% (average income of $1,299,300 during that year).

A typical response - and the one that Rosen makes is that we ought to consider all federal taxes. This isn't obviously correct. Social security taxes are capped at a certain income level because the amount that a person can collect in benefits are also capped. If I can't collect more than x dollars in benefits, the argument goes, why should I keep paying into the system after a certain income level.

But let's put that aside.

The CBO does just what Rosen wants to do, adding in social security, excise and corporate taxes. This reduces progressivity but certainly does not eliminate it. The top quintile has an effective rate of 25.2% compared to 17.3% for the fourth and 14.1% for the third quintiles. The top 5% pays 28.7% of its income in federal taxes while the top 1 % pays 31.4%.

So, if we define the super rich as the top 1%, these households pay do not pay a similar federal tax rate. In fact, they pay an effective tax rate that is more than twice that paid by those who are smack in the middle.

You can argue that this isn't progressive enough and there have been years of greater progressivity but these numbers are more or less comparable to what we have seen over the past thirty years. Indeed, the most dramatic decline in effective federal tax rates (considering all taxes) has not been among the rich, but among the poor and lower middle classes. From the last year of the Carter administration to 2005, the effective rate for the lowest quintile has gone from 7.7% to 4.3% and, for the second quintile, from 14.1% to 9.9%.

Rosen argues that the rich pay most of the federal income tax (and of all taxes) because they make a lot of money. That is certainly true. But the tax system remains progressive. According to the CBO, the top 1% earned 55.1% of total income in 2005 and paid 86.3% of the total income tax and 68.7% of all federal taxes.

Now, one can bemoan the fact that the top 1% make that much money, but the problem, if there is one, isn't the tax system.

*As a bonus for you real policy wonks, the CBO study may not precisely match other tables because it adjusts for household size and includes all pretax income. That doesn't change the story, but one could argue that the CBO slightly overstates the tax burden on higher income workers because it assumes that capital, i.e., the shareholders, pay corporate taxes. This is in keeping with what proponents of high corporate tax rates like to argue. Critics of corporate taxation argue that they tend to fall on labor and consumers. I don't think that this makes a huge difference here and, in any event, I would not expect to many who lean left on these issues to argue that corporate taxes are simply passed on to workers and customers.

15 comments:

Dad29 said...

Nice clarification of the issue.

jimspice said...

...but these numbers are more or less comparable to what we have seen over the past thirty years.

But what it not comparable over that time is the disparity in income distribution. If tax rates remain constant, but real income increases more steeply as you climb up the quintiles, the rich take home a larger share of the pie over time.

You can argue that this isn't progressive enough and there have been years of greater progressivity...

I would and there have. Take a look at the top tax rates of the post-WWII rebuilding years and you see rates topping 90% in some of the years representing the greatest economic growth.

Spice

Anonymous said...

Yes, one can bemoan the fact that the top 1% of taxpayers take home an ever-increasing slice of national income, and, yes, that fact has at least some correlation with the tax system. As suggested above, the top marginal rate during the Eisenhower administration was 91%; the top marginal rate during most of the years of the Reagan administration was 50%. Higher marginal rates send a signal to the corporate boards that allow CEO's to make 500 times the wage of the average worker that such compensation is neither necessary nor appropriate -- that the greed we've seen on Wall Street, and which even your candidate has decried, should be discouraged, as morally wrong. (When top marginal rates were much higher, Fortune 500 CEO's made a much lower multiple of the average worker's wage. Perhaps not completely cause and effect at work there, but there's some correlation.) And now people are complaining that the top marginal rate Obama's proposing, of 38.5%, is too high -- while the same folks, or at least McCain, complain about the greed on Wall Street.

Tax policy reflects who we are as a people. Something is wrong with a country where hedge fund managers can rake in incomes of over a billion dollars, much of it taxed at 15% capital gains rates, while millions are without health insurance.

Publius said...

We be sure not to confuse class envy with tax envy.

CEOs and business owners who are in the 95th quartile have done so because the media succeeded at running a company or starting a company. This is does not of course include "old money".

In many these people's success in business and management has led to the creation of many new jobs.

Of far greater issue than who we get the money from is probably that we need to start spending less of it with every succeeding year we will find ourselves servicing an ever-increasing debt.

TexPat said...

jimspice wrote: Take a look at the top tax rates of the post-WWII rebuilding years and you see rates topping 90% in some of the years representing the greatest economic growth.

You may well correctly argue that "there have been years of greater progressivity" but citing past top marginal tax rates doesn't do anything to show that in the context of the data cited by Prof. Esenberg. To know that we would need to see the numbers for the top one percent and the top quintile going back through history. The CBO data only goes back to 1979 but it does provide some insight.

Here are the averages for '79-86 ('86 being the last year that top marginal tax rates were 50% or more)

SHARE OF TOTAL NATIONAL INCOME:
Top quintile: 47%
Top 1 percent: 11%

SHARE OF TOTAL TAXES PAID:
Top quintile: 56%
Top 1 percent: 15%

EFFECTIVE TAX RATE:
Top quintile: 25%
Top 1 percent: 30%

Here are the 2005 stats with the increase from '79-'86 in parenthesis:

SHARE OF TOTAL NATIONAL INCOME:
Top quintile: 55% (+8)
Top 1 percent: 18% (+7)

SHARE OF TOTAL TAXES PAID:
Top quintile: 69% (+13)
Top 1 percent: 28% (+13)

EFFECTIVE TAX RATE:
Top quintile: 26% (+1)
Top 1 percent: 31% (+1)

So, since the time of high marginal tax rates the wealthy have increased their share of total income by about 8 percentage points but their share of the total tax burden by 13 percentage. Meanwhile their effective tax rate has remain largely unchanged (actually going up slightly).

So does that make the current era more progressive or less progressive than in the past?

Anonymous said...

To actually have growth or even pay back debt, you would need to do more than just redistribute. Everyone would need to pay more taxes or at least stay the same while the wealthy pay more... wouldn't they?

Anonymous said...

Anon 11:10

No, you need to cut spending.

JJ

Brian said...

Prof,

I'm glad someone like you is willing to crunch the numbers, and maybe I'm just too much of a half-glass-empty type of guy, but does it really matter? Do you actually think a socialist like Rosen is interested in the least in actual facts on this issue? These are the people who believe that Barry is going to pass a tax cut that includes the 30-40% of Americans who pay no taxes.

Serious question.

sekoras said...

read this first

http://american-platform.com/america/2008/10/10/federal-income-taxes-who-pays-and-how-much/

Rachel said...

the super rich also hold onto the wealth. wealthy people/businesses make $400 to $1 compared to middle class. 20 years ago it was $35 to $1. This means the pay and distribution of money from those with money (businesses and those who own the businesses) is 400 to 1 compared to 35 to 1 twenty years ago. I know I've said that twice but this is the CORE reason so many middle/poor people are in trouble today and why it's so important to have the gov't tax a little easier on those who make less. I make approx $300k a year and if you study economics it's easy to figure out Obama's plan.

Mack said...

A few holes re: super rich taxation. Biggest HOLE - Most comment examples use tax tables on income ("exposed" income) Income reduced by normal deductions AND THEN tax advantaged loopholes and writeoffs eg: leased vehicles, Bldg. and equip depreciation, depriciation swaps and more all flowing to an "S" corp. and the owner. THEN tax payer owned "carefully currently write off annnually improved" property/and or equipment leased back to his own corporation and ... on and on. Correctly structured Holding Corp Corporations with 3 or more Sub Corps to buy, sell and (expense W/Off)services sell depreciable assets and take shrinkage to inventory and equipment etc, etc. Then you have the "unexposed" income "3 blind T" investment corporate trusts, realestate trusts, offshore Sub corporations and trusts...The upper middle and surely middle and lower income don't have a clue and can not take these advantages. All in all the super rich pay the lowest income of all classes as a % of their income except for those paying nothing.

Anonymous said...

The rich get richer and everyone else gets poorer and sicker.

http://helpfixamericafirst.blogspot.com/2011/04/rich-get-richer-and-everyone-else-gets.html

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