May 7, 1998
Still Taxing the Truth:
The Tax Foundation and "Tax Freedom Day"
On April 15, the Tax Foundation issued a report saying that the average American must work until May 10 this year's "Tax Freedom Day" to pay taxes. In each year since 1993, the Tax Foundation has claimed the average American's tax burden has increased and pushed Tax Freedom Day later in the year. A report also released in April by the Center on Budget and Policy Priorities shows that Tax Freedom Day and related Tax Foundation claims about tax burdens are based on misleading and inaccurate methods that significantly distort the figures to make taxes on a typical middle class family look as if they are higher and rising more rapidly than they actually are.
As this year's supposed Tax Freedom Day of May 10 draws near, the Tax Foundation's claims may once again receive attention. As highlighted in the recent analysis from the Center on Budget and Policy Priorities, here are seven key points worth noting about the Tax Foundation's methods:
1. The Tax Foundation's use of averages is severely flawed and substantially exaggerates middle-class tax bills.
In contending Americans must work until May 10 to pay their taxes, the Foundation takes what it says is the total amount paid in federal, state, and local taxes and simply divides this amount by the Foundation's estimate of the total amount of income in the nation. It calls this figure the taxes that the average American or average taxpayer must pay. This methodology assumes that everyone pays the same percentage of income in taxes, which of course is not correct. The wealthy pay a substantially higher percentage of income in taxes than the middle class or the poor do.
The federal personal income tax is a progressive tax. The typical middle-income family is in the 15 percent federal income tax bracket. High-income families are in brackets with marginal rates more than twice that high and pay substantially higher percentages of income in federal income tax. The average tax burden is a misleading figure because it significantly exceeds the percentage of income that both families in the middle of the income spectrum and even families in the next-to-top fifth pay in federal taxes.
The problem of using averages as the Tax Foundation does is easily seen. Suppose four families with $25,000 incomes each pay $1,250 in income tax or five percent of their income while one wealthy family with $500,000 in income pays $125,000 in income tax, or 25 percent of its income. These five families pay an average of 22 percent of their income in federal income taxes (total tax payments of $130,000 divided by total income of $600,000).
But the 22 percent figure is misleading. The four moderate-income families pay five percent of their income in income tax, not 22 percent. Using averages when talking about tax burdens produces skewed results; it ascribes tax rates to the average person that only taxpayers at considerably higher income levels pay.
The Tax Foundation's averaging approach is flawed in the same regard with respect to various other types of taxes. Their methodology assumes that middle-class families pay the same percentage of income in estate taxes as a family with a multi-million dollar income. But estate taxes are paid on only the largest one to two percent of estates; all smaller estates are exempt. The Tax Foundation also erroneously assumes that typical middle-class families pay the same percentage of income in corporate income and capital gains tax as wealthy investors and stockholders.
2. The tax burdens that the Tax Foundation says the average family bears are much higher than the estimates of the Congressional Budget Office and the Congressional Joint Committee on Taxation, authoritative institutions headed by Republican appointees.
Data from CBO and the Joint Committee on Taxation indicate that for families in the middle of the income scale, federal tax burdens are neither at an all-time high nor increasing. In this year's Tax Freedom Day report, the Tax Foundation estimates that families on average will pay 24.0 percent of its income in federal taxes, including income tax, payroll tax, and other taxes. By contrast, the CBO estimates that families in the middle of the income scale pay 19.7 percent of income in federal taxes, while the Joint Committee on Taxation's estimate is 15.9 percent.
3. Under the Tax Foundation's methodology, the increase in federal revenue as a share of the economy in recent years is essentially portrayed as a rise in the average family's tax burden. Such a portrayal is mistaken; the increase in revenue as a share of the economy largely reflects the increased taxes being collected from high-income individuals as a result of large increases in their capital gains income and their salaries and bonuses.
CBO director June O'Neill recently testified that tax receipts have risen as a share of the Gross Domestic Product in the last few years "mainly because realizations of capital gains were unusually high and because a larger share of income was earned by people at the top of the income ladder, who are taxed at higher rates."(1) This trend is continuing into 1998. In its May estimate of a higher federal budget surplus, CBO noted that increased revenues are coming largely from taxes on non-wage income, with a major component likely attributable to increased capital gains realization. These increased tax collections have little effect on the taxes paid by typical middle-income families.
4. There is no evidence of a trend toward higher taxation among families in the middle of the income spectrum.
The CBO data show that the federal taxes paid by the fifth of the population in the middle of the income spectrum consumed 20 percent of these families' income in 1979 and 19.4 percent of income in 1989 and would have consumed 19.7 percent of income in 1998 in the absence of the tax cuts enacted last year. The Tax Foundation itself acknowledged this point in a February 1998 release, where it stated that "...federal taxes as a percent of income will be lower on the median single- and dual-income families in 1998 than two decades ago,...even without the 1997 Tax Relief Act."(2)
A similar trend is at work at the state and local level. Commerce Department data indicate that state and local taxes equaled approximately 10.1 percent of income in 1997, exactly the same figure as 20 years earlier in 1977.
5. The typical family's tax bill will shrink somewhat in the next few years.
Last year's tax-cut legislation contained various tax reductions benefitting middle-income families that do not begin to take effect until this year and phase in over several years. These tax cuts will reduce the percentage of income the typical family pays in taxes in the next few years. The trend for state tax burdens also is likely to be down in the next several years.
6. The Tax Foundation's methodology contains other shortcomings that make taxes look larger as a percentage of income than they actually are.
The Foundation counts as taxes items that are not taxes, such as optional Medicare premiums that older Americans pay if they wish to receive coverage for physicians' services under Medicare and rental payments that individuals or businesses pay to state or local governments to rent property those governments own. The Foundation's inclusion of items that are not taxes overstates state and local tax burdens by about one-seventh.
Furthermore, the Tax Foundation counts capital gains taxes as part of the taxes people pay but fails to count the capital gains income on which these taxes are levied as part of people's incomes. Counting taxes while failing to count the income on which the taxes are paid makes taxes appear larger as a percentage of income than they actually are.
7. The Tax Foundation numbers frequently are used by those who argue the federal income tax code should be replaced with a flat tax or consumption tax on the grounds that income tax burdens on middle-class families have exploded and reached crushing levels. In fact, the typical family would likely pay higher taxes under the proposed alternatives to the income tax.
Congressional Budget Office analyses show that even before the federal income tax cuts enacted last summer, about three of every four families were paying less than 10 percent of their incomes in federal individual income taxes. Nevertheless, the Tax Foundation figures often are used to create an impression that federal income tax burdens on middle-class families have risen sharply and reached crushing levels. These misimpressions are fanned by some who favor replacing the income tax with a flat tax or national sales tax and who portray such a change as benefitting hard-pressed, over-taxed, middle-income families.
Since affluent Americans pay a much higher percentage of income in federal income taxes than other families do under our current, graduated income tax structure a reality the Tax Foundation's figures obscure virtually all proposals to shift to a flat or national sales tax would result in windfalls for those at the top of the income spectrum and require either increased taxes on middle- and low-income families or substantially reduced revenue collections. Reductions in revenue could usher in a new era of budget deficits or lead to large reductions in programs upon which the middle class relies.
1. June E. O'Neill, The Economic and Budget Outlook: Fiscal Years 1999-2008, Testimony before the Senate Budget Committee, January 28, 1998; and Congressional Budget Office, "Monthly Budget Review," May 6 , 1998.
2. Tax Foundation, Family Tax Burdens 20 Years Later, Revisited, February 5, 1998.
Additional tax analyses can be viewed in our library.