September 4, 1996
Overstating the Taxes the Typical Household Pays
by Richard Kogan
For a more up-to-date discussion of tax burdens, click here.
In recent weeks, a plethora of syndicated columns, campaign ads, and statements have broadcast a simple, quotable, and disturbing message taxes have climbed so high in the past few years that the typical family now pays about 40 percent of income in taxes.
For example, in May, the Republican National Committee issued a press release contending "the average family pays 38.2 percent o its income in taxes," a claim reported as fact by Charles Krauthammer in a column on August 23. Three days before Krauthammer's column, James K. Glassman wrote in his Post column that the typical family pays more than 40 percent of its income in taxes, citing the Tax Foundation as his source. In addition, at an August 21 press conference held by Women for Tax Reform to unveil a series of anti-Clinton ads, an organization spokeswoman stated that because of this 40 percent tax bite, "an average earner of $30,000 a year gets only $18,000 instead."
These claims are inaccurate. The typical family does not pay anything close to 40 percent of its income in federal, state, and local taxes. A figure of 27 percent is more accurate. Similarly, a family making $30,000 does not pay anything close to $12,000 in taxes. Even the wealthiest one percent of the population people with incomes averaging $650,000 a year do not pay as much on average as 40 percent of their income in taxes.
Claims that the average family has seen its taxes rise $1,500 in the past few years also are off base. These various charges appear to be based on one or more of a series of errors and misuses of data.
- Some of the contentions about high tax burdens appear to have been based not on CBO or OMB data on tax collections but on a series of Commerce Department data on government receipts that includes Medicare premiums and certain intragovernmental trust fund transfers as receipts. Those who use the Commerce Department data to claim tax burdens are inordinately increasing are counting Medicare premiums and other non-tax receipts as though they were taxes without explaining they are doing so. When more people age and enroll in Medicare, this approach makes it look as though the government has raised the typical family's taxes.
- Virtually all of the inaccurate or misleading claims use average tax burdens as though they represented the amount of tax that a typical family pays. If four middle-income families pay $3,000, $4,000, $5,000, and $6,000, respectively, in taxes, and one very wealthy family pays $82,000 in taxes, the average tax paid by these five families is $20,000 ($100,000 in total taxes divided by five families). But four of the five families pay $6,000 or less.
When average tax burdens are presented as the amount that the "average family" or "typical family" pays, the larger taxes that the wealthy pay are used to make the taxes paid by average or typical middle-class families look much larger than they really are. This is why virtually all analysts without a political axe to grind use the tax burdens of the median family (the family in the middle of the income spectrum) rather than average tax burdens when describing the level of taxes that typical middle-class families owe.
Using averages rather than medians overstates the income of the typical American household by 36 percent. It overstates the proportion of income it pays in federal income tax by 71 percent.
Recent Statements About Tax Levels
1. The average family pays 38.2 percent of its income in taxes... (RNC news conference, 5/8/96)
2. Americans on average pay the government at all levels 38 cents on every dollar earned in taxes. (Charles Krauthammer, Washington Post, 8/23/96, page A21.)
3. Total taxes as a percent of income: 34.8% (Tax Foundation, Special Report, 4/15/96, page 4)
4. Currently, the typical family (two parents, two children) pays more than 40 percent of its income in taxes (federal, state, local) according to the Tax Foundation. (James K. Glassman, Washington Post, 8/20/96, page A17.)
5. The federal tax burden under Mr. Clinton stands at 20.5 percent of gross domestic product, the highest it has been in the post-World War II era. (Donald Lambro, Washington Times, 9/2/96, page A17.)
6. We're the ones who see 40 percent of our wages disappear before we get our paycheck. That's what the combined tax bite now represents. That means that an average earner of $30,000 a year gets only $18,000 instead. (Francis B. Smith, Women for Tax Reform, Statement at National Press Club, 8/21/96, announcing a series of anti-Clinton adds.)
7. A 15% tax cut is a pay raise of more than $1,600 per year for the average American family. (Dole/Kemp press release, 8/20/96.)
Issues Concerning Average Tax Rates
Recent statements create the impression that average families and typical families pay about 40 percent of their income in taxes. In fact:
- CBO and OMB data indicate that total taxes constitute 29.8 percent of total income, not 38 percent or 40 percent. Thus, average tax burdens are 29.8 percent, rather than being close to 40 percent.
- This 29.8 percent figure is slightly higher than it otherwise would be because of the current, unusually high level of corporate profits and capital gains realizations. These high levels of profits and capital gains realizations result in more tax collections, but CBO expects these levels to subside in the years ahead. For these reasons, CBO forecasts that the average tax rate will decline slightly under current law between now and 2002.
- Furthermore, this 29.8 percent figure is an average, not a median. The tax rate paid by median or typical households those exactly in the middle of the income spectrum is lower than the "average" tax rate because the average rate includes the higher tax rates the very wealthy pay. That Bill Gates, Ross Perot, and Malcolm Forbes pay federal income taxes at higher rates does not mean the typical American does. The typical or median household now pays about 27.3 percent of income in federal, state, and local taxes.
- Furthermore, if tax rates are increased on only the wealthy, average tax rates rise, but the tax rates that typical Americans face do not. This is another area where data on average tax burdens can be used in a misleading fashion. For example, if the federal income tax paid by four middle-income families remains unchanged, while the income tax paid by a wealthy family rises $7,500, the average tax burden for these five families has increased $1,500 ($7,500 divided by five families). But to claim the typical family or average family has shouldered a $1,500 tax hike would be misleading. This is another illustration of why median rather than average tax rates and tax burdens should be used in such circumstances.
- The figures cited here include state and local taxes as well as federal taxes. Nearly all of the increase in total taxes since 1980 has been in state and local taxes, not federal taxes. Federal tax rates are not the highest in history, or even in peace-time history, although state and local tax rates are at their historical peak. Most of the recent attacks on high tax levels imply that federal taxes have risen sharply.
What is the Average Tax Rate?
The average tax rate that Americans pay is determined by a simple calculation one divides the total taxes that Americans pay by the total national income. The average tax rate is therefore the same percentage as "revenue as a share of the economy" or "revenues as a percentage of the Gross Domestic Product (GDP)."
Data on average tax rates are available from CBO and OMB. CBO publishes data for federal revenues; OMB publishes estimates for state and local revenues. Here is what the historical data show:
Table 1: Average Tax Rates
(Revenues as a percentage of GDP)
Fiscal Year Federal State/Local 1 Total 2002 (current law projection) 18.5% 10.8%* 29.3% 1996 (est.) 19.1 10.8* 29.8 1995 18.9 10.8 29.6 1986 17.6 10.4 28.0 1982 19.2 10.0 29.2 1981 19.7 9.7 29.3 1980 19.0 9.8 28.8 1969 19.7 9.3 29.1 1990-99 avg (est.) 18.4 10.7* 29.1 1980-89 avg 18.4 10.2 28.5 1970-79 avg 18.0 10.3 28.3
NOTES: Figures may not add due to rounding. Federal revenues as a percentage of GDP are from CBO's Economic and Budget Outlook, May 1996, pages 37 and 137. State and local revenues as a percentage of GDP are determined by dividing tax levels from OMB's Historical Tables, January 1996, p. 256, by GDP levels as published by CBO. (CBO's GDP estimates are used because they reflect the revision to historical GDP estimates completed by the Bureau of Economic Analysis after publication of the OMB tables.)
* No nationwide projections of state and local revenues exist, so for the purposes of this table they are assumed to remain at the 1995 rate of 10.8 percent.
As these data indicate, average federal taxes are not at the highest level in history. Moreover, CBO projects a decline in average federal tax rates even without changes in current tax law. One reason is that the CBO data show an abnormally high level of corporate income tax receipts in 1995 and 1996, based on abnormally high corporate profits. CBO expects corporate profits to return to more normal levels in the future.
CBO projects average federal tax rates of 18.5 percent of GDP by 2002. This level is only modestly higher than the average of the last two decades and is lower than the average tax burden was in many past years. (It also should be noted that the federal deficit for 1996 is projected to be 1.6 percent of GDP. This is lower than the 1970s average of 2.1 percent of GDP and much lower than the 1980s average of 4.0 percent of GDP.)
Most important for purposes of this analysis, Table 1 shows that average tax rates are not 38 percent to 40 percent, but about 29.8 percent. This raises a question where do the 38 percent or 40 percent figures come from? None of the individuals or organizations that have cited these figures in recent weeks have provided an explanation for their figures. Those citing such figures appear to have made one or more of the following types of errors.
Counting Medicare premiums and other items as taxes. A number of conservative outlets are relying on tax analyses by Bruce Bartlett, a staff member of the conservative National Center for Policy Analysis and a Dole advisor. Bartlett does not use the standard definition of federal tax revenues that the Congressional Budget Office and the Office of Management and Budget use. Instead, he relies on estimates of government receipts published by the Commerce Department.
The Commerce Department data, however, include as government receipts two large items (among others) that are not tax revenues. The Commerce data include as revenue the premiums that most elderly people choose to pay to purchase Medicare Part B (physician insurance) from the government. This is no more a tax than any other voluntary purchase, and neither CBO nor OMB treats the income from these premiums as tax revenue. (Since the Medicare bill that Congress passed in 1995 would have increased Medicare premiums, and the bill's supporters said they were not raising taxes, most of them apparently do not consider Medicare premiums a tax, either.)
The Commerce data also includes as a government receipt the amounts transferred from the Treasury to the Civil Service and Military Retirement Trust Funds. This intra-governmental transfer is a bookkeeping device, not a tax. Neither CBO nor OMB treats it as a tax.
Using these Commerce Department data as a measure of taxes the federal government collects results in an estimate of total receipts that is substantially higher than the tax revenue figures that CBO and OMB uses. It also produces an estimate that is growing more rapidly than the CBO and OMB data on tax collections. These Commerce Department data are now being used in some quarters to make it appear as though tax burdens are higher and growing more swiftly than is the case. 2
- Some analyses miss income and consequently overstate taxes as a percentage of income. If income is understated, taxes as a percentage of income will be overstated. CBO data show that total federal taxes equal 19.1 percent of national income in 1996. At the same time, CBO's estimates of federal tax rates for different types of families at different income levels appear to yield a higher figure for taxes as a percentage of income.
This seeming anomaly occurs because analyses of tax rates for particular types of families do not rely on aggregate estimates of national income, but rather on reported income from IRS and Census reports. It is well known that the IRS and Census data miss a significant amount of income some people do not fully report their incomes on these surveys or on their tax returns. That these IRS and Census data understate income is accepted by virtually all reputable analysts, regardless of their political leanings.
A Tax Foundation estimate that the average federal, state, and local tax rate is 34.8 percent appears to be based on the data for particular types of families that is, the data that are characterized by significant underreporting of income. The Tax Foundation estimate is five percentage points higher than the 29.8 percent figure cited above based on the CBO estimates of national income estimates that are not flawed by income under-reporting. CBO data also show that the average tax burden figure appears to rise about five percentage points when the less complete IRS and Census data on various types of families are used. This appears to be the source of the overstatement of tax burdens in the Tax Foundation report.
- Some analyses use types of households that have higher income and hence higher tax burdens than the typical U.S. household. For example, CBO data show that households with children average about $6,000 more in income than households without children. Households without children include many people who are just starting their careers and have small incomes or who have retired and have lower income as a result. It is not appropriate to apply tax figures for one type of household to all U.S. households.
To gain a sense of the degree of distortion in the increasingly cited figure that average Americans pay 40 percent of their income in taxes, consider the following. CBO data suggest that the average federal tax rate of the wealthiest one percent of the population with average household income of $650,000 is 26 percent. Data from the Institute of Taxation and Economic Policy suggest average state and local tax rates on the wealthiest one percent of the population may reach nine percent of income. 3 The total is 35 percent. Even the wealthiest one percent of Americans do not pay an average of 40 percent of their income in taxes.
Another way to see the degree of distortion in the 40 percent figure is as follows. In 1995, federal, state, and local revenues totaled $2,128 billion, according to CBO and OMB data. If the average tax rate were 40 percent, then total national income must have been $5,323 billion (since $2,128 billion is 40 percent of $5,323 billion). Yet total national income GDP was $7,181 billion in 1995. To claim the average tax rate is 40 percent requires overlooking more than one-fourth of the nation's income.
Averages are Not Typical
Even when computed accurately, averages can be used in a misleading fashion. In analyzing the earnings and taxes of typical middle-class families, one should use medians, not averages. (See the box below.) The typical American household one with income higher than half of all households and lower than the other half pays approximately 27.3 percent of its income in taxes. The federal tax rate for such a household, including all federal taxes, is approximately 16 percent.
The average tax rate equals total taxes divided by total income. The problem with data on average tax rates is that it gives disproportionate weight to wealthy people. By averaging Bill Gates, Ross Perot, and Malcolm Forbes in with the rest of us, an "average" overstates both the income of a typical American and the amount of taxes the typical American pays.
The Average American versus The Typical American
Consider a hypothetical example: four families with $25,000 in income each pay $5,000 (or 20 percent of income) in local, state, and federal taxes, and one wealthy family with $500,000 in income pays $180,000 (or 36 percent of income) in taxes. The average income of those five families is $120,000 total income of $600,000 divided by five families. The average tax rate for these five families is 33 percent total income of $600,000 divided by total taxes of $200,000.
Yet four of these five families have incomes of $25,000 rather than $120,000. Those four families pay 20 percent of their income in taxes, not 33 percent. In what sense is a family income of $120,000 and a 33 percent tax rate typical?
Those who use the average tax rate instead of the median tax rate, such as the Tax Foundation and others cited here, violate the standard approach that most analysts use and thereby exaggerate the proportion of income the typical family pays in taxes. In the example cited here, the median family the family that falls in the middle, with half of the families earning more income and half earning less pays 20 percent of its income in taxes, not 33 percent.
A sounder approach is to use the median, the point at which half the population has higher household income and half lower. Unfortunately, by using an average instead of a median and presenting it as representing the tax burdens of the "average family," various political organizations and columnists have fostered misleading impressions of the tax rates that typical families face, especially with regard to progressive taxes such as the income tax. This approach also understates the proportion of income the typical family pays in regressive taxes such as payroll and excise taxes.
The use of averages instead of medians overstates the income of a typical American household by 36 percent. It overstates the proportion of income the typical household pays in federal income tax by 71 percent. This approach also understates the rate of payroll and other federal taxes the typical family pays by 14 percent. Combining all federal taxes, use of average tax rates overstates the percentage of income that the typical household pays by 21 percent. Because state and local taxes are generally regressive, use of the average understates by eight percent the percentage of income that the typical family pays in state and local taxes.
Finally, the CBO data on federal tax rates in selected years shows that the median federal tax rate is currently much the same as it has been since 1977.
Table 2: Typical vs Average Tax Rates
(Typical taxes are those for households with median income)
Typical Average Household income $35,536 $48,165 Federal tax rates 15.8% 19.1% State/local tax rates 11.5% 10.8% Combined tax rates 27.3% 29.8%
NOTES: Figures may not add due to rounding. Household income comes from CBO's 1995 tables on projected 1996 incomes. Those same CBO tables provide data on average effective tax rates for 1996 and averages for the third quintile of households (which is taken as a proxy for the median household). We adjusted the CBO tax rate figures proportionately so that the total (average) tax rate equals federal revenues as a percentage of GDP. Data on state and local tax rates come from a study by the Institute on Taxation & Economic Policy. This study shows income and tax rates by quintiles for all 50 states, the District of Columbia, and the U.S. average for 1995; we adjusted the rates proportionately so the total tax rate equals state and local revenue as a percentage of GDP. This table assumes that the incidence of state and local taxation did not change from 1995 to 1996.
Average Tax Levels, Median Tax Levels, and Tax Cuts
When proposals to cut taxes are discussed, the average tax cut is sometimes cited by tax cut proponents. But here, too, use of averages can distort the effects on typical households.
Consider the proposal to cut the federal individual income tax by 15 percent across the board. If a 15 percent cut had been fully effective in the current year, it would have reduced average federal taxes from 19.1 percent of income to 17.8 percent of income, a difference of 1.3 percentage points. A household with median income, however, would have received a tax cut equal to only nine-tenths of one percent of its income. Not only would a typical family have received a smaller tax cut in dollar terms than a wealthy family, but the typical family also would have had its taxes reduced less as a percentage of income.
A different way to make this point is to imagine a 15 percent reduction in payroll taxes instead of individual income taxes. If in effect in the current year, a 15 percent payroll tax cut would provide a smaller average tax cut than a 15 percent cut in income tax rates. But the typical household in the middle of the income spectrum would be $218 better off with the 15 percent payroll tax cut than with the 15 percent income tax cut. Only higher-income households would benefit more from the income tax cut.
These examples further illustrate the problems with using averages rather than medians when assessing the tax burdens of U.S. households and proposals to change the tax code.
Responses to Misleading Claims
With the foregoing analysis as background, the misleading nature of the claims cited at the start of this paper becomes more apparent. Taken in order:
CLAIM: The average family pays 38.2 percent of its income in taxes... (RNC news conference, 5/8/96)
Americans on average pay the government at all levels 38 cents on every dollar earned in taxes. (Charles Krauthammer, Washington Post, 8/23/96, page A21.)
FACT: A typical household pays 27.3 percent of its income in taxes, not 38.2 percent. Of that amount, 15.8 percent is federal taxes.
CLAIM: Total taxes as a percent of income: 34.8% (Tax Foundation, Special Report, 4/15/96, page 4)
FACT: This figure is overstated because some income is not included in the calculations. Total taxes now average about 29.8 percent of income. In addition, using an average includes the higher tax rates applicable to the very wealthy. Median-income households now pay approximately 27.3 percent of income in taxes.
CLAIM: Currently, the typical family (two parents, two children) pays more than 40 percent of its income in taxes (federal, state, local) according to the Tax Foundation. (James K. Glassman, Washington Post, 8/20/96, page A17.)
FACT: It is not clear that two parents and two children is a "typical" family. In any case, CBO data show that households with children (who have higher income than those without children), pay about two percent more of their income in federal taxes than all median-income households. It is very unlikely they pay state and local taxes at higher rates, since state and local tax rates generally decrease as income increases. Therefore, the typical family with children probably pays between 29 percent and 29.5 percent of income in total federal, state, and local taxes two percentage points more than the median tax rate of 27.3 percent.
Who pays 40 percent of household income in federal, state, and local taxes? As discussed previously, even the wealthiest one percent of U.S. households pay an average of 35 percent of their incomes in taxes.
CLAIM: The federal tax burden under Mr. Clinton stands at 20.5 percent of gross domestic product, the highest it has been in the post-World Ware II era. (Donald Lambro, Washington Times, 9/2/96, page A17.)
FACT: The figure cited by Mr. Lambro is from Commerce Department data on federal receipts, including non-tax receipts. By characterizing this figure as representing the federal tax burden, Mr. Lambro unwittingly counts Medicare premiums and various intragovernmental transfers as taxes. As explained earlier, using these Commerce figures instead of CBO data to measure federal taxes produces misleading results that overstate both the level and the growth in taxes. The CBO data show that federal revenues are 19.1 percent of GDP, which is considerably lower than Mr. Lambro's figure and is not a post-war peak.
CLAIM: We're the ones who see 40 percent of our wages disappear before we get our paycheck. That's what the combined tax bite now represents. That means that an average earner of $30,000 a year gets only $18,000 instead. (Francis B. Smith, Women for Tax Reform, Statement at National Press Club, 8/21/96, announcing a series of anti-Clinton adds.)
FACT: Even if the average effective tax rate is 40 percent on some very wealthy subset of the population, it surely is not on those making $30,000 per year. Table 2 showed that tax rates on households making $35,500 per year are about 27.3 percent. The tax rate would be even lower about 25.5 percent for those making $30,000.
CLAIM: A 15% tax cut is a pay raise of more than $1,600 per year for the average American family. (Dole/Kemp press release, 8/20/96)
FACT: If a 15 percent cut in individual income tax liability is worth more than $1,600 to the average American family, the average American family must have federal income tax liability of about $10,700 (since 15 percent of $10,700 is about $1,600).
CBO tables show, however, that a household of median income has an average individual income tax liability of $2,165, not $10,700. Furthermore, a household with average income (which is higher than the median, as noted) has individual income tax liability of $5,389. Households with income between $75,000 and $100,000 have average income tax liability of $9,758. In reality, the "average American family" of this campaign press release probably has income between the 80th and the 90th percentile that is, it probably has income higher than at least 80 percent of the U.S. population.
1. Data on state and local tax receipts are collected by the Department of Commerce on a "National Income and Product Accounts," or NIPA, basis. Tax accounting methods vary so greatly among states that it is necessary to use NIPA data to achieve consistency among states, even though the NIPA methodology may include some receipts that are not tax revenue and thus may overstate state and local tax levels.
2. For a more detailed explanation of this issue, see Kathy Larin, Taxes: The Highest in History?, CBPP August 5, 1996.
3. CBO and ITEP produce estimates of average tax rates by income category, including for the wealthiest one percent of the population. Those estimates are necessarily based on Census and IRS data, which is known to miss some income. If the resulting estimates are then adjusted proportionately to match CBO data on total national income, the figures cited here are obtained. Even if not adjusted, the CBO and ITEP tax rates reach 40 percent only for the wealthiest one percent of the population.