January 21, 1999
Information and Misinformation about Federal Tax Burdens
by Iris J. Lav
The percentage of income that typical middle-class families pay in federal taxes is often overstated. For example, in her response to the President's State of the Union address, Congresswoman Jennifer Dunn said that "a typical mother and father who both work paid nearly 40 percent of their income in taxes." The often-stated 40 percent figure is rounded up from a Tax Foundation report that claims the typical two-earner family pays 36.7 percent of its income in federal, state, and local taxes combined. As described below, however, the Tax Foundation figure is based on a severely flawed methodology and is sharply at odds with estimates of tax burdens from much more authoritative sources, including the Congressional Budget Office and the Joint Committee on Taxation.
The historical trend in federal tax burdens is frequently misportrayed as well. The data do not support the contention, also made by Congresswoman Dunn, that current tax burdens are "...the highest percentage of income ever paid in taxes by American families." The federal taxes that a median-income family pays in 1999 will constitute a lower percentage of income than in 1977 and most years since then.
How Much Does a Median Income Family Pay?
The Tax Foundation report on which Congresswoman Dunn's 40 percent tax burden figure was based claims that federal taxes absorbed 26.1 percent of the income of a two-earner median-income family in 1997 and 24.4 percent of the income of a single-earner median-income family.
Analyses by CBO and the Joint Committee on Taxation, however, report much lower tax burdens. According to these authorities, which serve as the official estimating arms of Congress, typical families will pay between 16 percent and 19 percent of their incomes for federal taxes in 1999.
- The Congressional Budget Office estimates that a median-income family a family exactly in the middle of the income distribution will pay 18.9 percent of its income in federal taxes in 1999. The CBO analysis includes the effect of income taxes, Social Security and other social insurance taxes, excise taxes, and corporate income taxes. The median-income family in the CBO analysis has income of approximately $39,000.(1)
- According to the Joint Committee on Taxation, a family with income between $30,000 and $40,000 will pay 16.1 percent of its income in federal taxes in 1999, while a family with income between $40,000 and $50,000 will pay 17.5 percent of its income in taxes. The Joint Committee analysis includes the effect of income taxes, Social Security and other payroll taxes, and excise taxes, but not corporate income taxes.(2)
- The Tax Foundation's median two-earner family has income of nearly $55,000, which is about 50 percent higher than the median income for all families. But this higher level of income does not account for most of the discrepancy. The CBO analysis shows that federal taxes equal 19.9 percent of income for two-adult families with children and income of $55,000. The Joint Committee on Taxation shows that families with incomes between $50,000 and $75,000 pay 19.7 percent of income in federal taxes. Both figures are substantially below the Tax Foundation's claim of a 26.1 percent federal tax burden.
The Tax Foundation finds higher tax burdens because the methodology it uses to calculate those statistics is seriously flawed in ways that tend to inflate the measurement of taxes as a percentage of income. For example, the Tax Foundation methodology assumes that a median two-earner family with an income of about $50,000 pays the same percentage of income in corporate income taxes and estate taxes as a wealthy family with income of $5 million and extensive investments. That is not a valid assumption; it is widely accepted that most corporate income taxes and virtually all estate taxes are paid by high-income taxpayers. This assumption in the Tax Foundation methodology overstates the tax burden that middle-income families bear.(3)
Are Tax Burdens Rising for Typical Families?
Various measures show that taxes on median-income families have remained stable or declined slightly over the last two decades.
Congressional Budget Office analyses show that the federal taxes paid by the 20 percent of families in the middle of the income scale equaled 19.5 percent of income in 1977 and 19.2 percent of income in 1985. As stated above, taxes on the middle 20 percent of families are estimated to equal 18.9 percent of income in 1999, a level lower than in any year since 1977 for which CBO data are available with the exception of 1983. (See chart.)
- A Treasury Department analysis shows that a middle-income family of four with two children will pay a smaller percentage of income in federal individual income tax in 1999 than in any year since 1966.(4)
- The Treasury analysis also shows that families of four with double the median income, nearly $110,000 in 1999, will have the lowest income tax burden of a family with twice the median income since 1972.
Are Tax Burdens Rising Overall?
Total federal tax collections measured as a percentage of the economy taxes as a percentage of GDP do appear to have risen in recent years. So have overall average tax burdens as shown in Census data. These increases are due in large part to the extraordinary increase in capital gains income and other income received by high-income taxpayers that has occurred over the past few years as the stock market has soared; these increases in capital gains income and hence in capital gains taxes have little effect on the tax burdens of most Americans.
Average Taxes is Not the Same as Tax Burden
Various measures of average taxes are often described as representing the tax burden on typical or average middle-class families. The common statistic of federal taxes as a percentage of GDP, for example, divides the total amount paid in federal taxes by the total amount of income in the nation. Similarly, the Tax Foundation relies on average taxes to compute its "Tax Freedom Day" each year. It also uses averages for a portion of the calculation that produces the figure that apparently is the source for Congresswoman Dunn's statement that "a typical mother and father who both work paid nearly 40 percent of their income in taxes." In addition, a recent op ed in The New York Times by National Center for Policy Analysis fellow Bruce Bartlett put forth a case for a tax cut that relied on average tax figures.
The average tax burden is a misleading figure, however. Middle-class families do not pay the average tax burden; they pay less than that. That is a result of the progressive structure of the federal income tax under which the wealthy pay a substantially higher percentage of income in federal taxes than the middle class or the poor do. While 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 much higher percentages of income in federal income tax than middle-class families do.
The problem of using averages 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 if used to portray middle-class tax burdens. 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.
- Most capital gains income is realized by high-income taxpayers; nearly three-quarters of all capital gains are realized by taxpayers with income exceeding $100,000. One-quarter of all capital gains income is realized by taxpayers with incomes exceeding $1 million.(5)
- Last year, CBO director June O'Neill 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."(6) Again, neither of these developments has much or any effect on families in the middle of the income scale.
Moreover, measuring tax burdens as a percentage of GDP can be misleading, because GDP does not include capital gains income. The taxes paid on capital gains income are counted as part of total tax collections, but the capital gains income is not counted as part of GDP. In other words, the taxes are counted, but the income on which the taxes are paid is not. This means that when capital gains income and capital gains tax collections both rise sharply, as has occurred in recent years, tax burdens rise when measured as a percentage of GDP more rapidly than tax burdens are, in fact, increasing. With capital gains income now playing a major role in increasing federal revenues, this distortion in the measure of tax burdens as a percentage of GDP has taken on added importance.
1. Estimates of Federal Tax Liabilities for Individuals and Families by Income Category and Family Type for 1995 and 1999. CBO Memorandum, May, 1998. The CBO analysis does not specifically provide the income level of the median-income family. The $39,000 figure cited here is the CBO estimate of the average income of families in the middle quintile of the income distribution. The average income of those in the middle quintile is a good approximation of the median income.
2. JCT Analysis of Revenue-Related Provisions in Tobacco Bill as Modified by Finance Chairman William Roth (JCX-45-98), June, 1998.
3. The Tax Foundation, The Tax Burden on American Families Rises Again, Special Report No. 74, revised. For a critique of the Tax Foundation methodology, see Iris J. Lav, The Debate Over Tax Levels: How Much Does a Typical Family Pay?, Center on Budget and Policy Priorities, March 16. 1998, and Iris J. Lav, Isaac Shapiro, and Robert Greenstein, Tax Foundation Figures Produce Misleading and Inaccurate Impressions of Middle Class Tax Burdens, Center on Budget and Policy Priorities, April 16, 1998.
4. Office of Tax Analysis, Department of the Treasury, October 20, 1998. In the Treasury analysis, family income is assumed to be at the median income for four-person families, which Treasury estimates to be approximately $55,000 in 1999, and the family is assumed to have two children.
5. Perspectives on the Ownership of Capital Assets and the Realization of Capital Gains, Congressional Budget Office, May 1997; Auerbach, Burman, and Siegel, Capital Gains Taxation and Tax Avoidance: New Evidence from Panel Data, University of Michigan Business School, Working Paper Series No. 98-13.
6. June E. O'Neill, The Economic and Budget Outlook: Fiscal Years 1999-2008, Testimony before the Senate Budget Committee, January 28, 1998.
Additional federal tax reports.