Revised April 16, 1998
Tax Foundation Figures Produce Misleading and Inaccurate Impressions of Middle Class Tax Burdens
by Iris J. Lav, Isaac Shapiro, and Robert Greenstein
On April 15, the Tax Foundation issued a report stating that on average, Americans must work until May 10 to pay taxes. The Tax Foundation computes what it presents as the percentage of income Americans on average pay in taxes and converts this to the portion of the year the average person has to work to pay his or her tax bill. Each year from 1993 through 1998, the Tax Foundation has claimed that the average American's tax rate has increased and "Tax Freedom Day" has been pushed later in the year. In 1998, the Tax Foundation claims Tax Freedom Day is May 10, up from May 9 the previous year.(1)
But the picture the Tax Foundation's reports portray that the tax burden on the average family is exceptionally high and has been rising is not accurate. The Tax Foundation's methodology substantially exaggerates the amount of taxes that typical or average middle class families pay. Under the methods the Tax Foundation uses, an increase in taxes solely on high-income taxpayers is pictured as increasing the taxes the average taxpayer pays. This methodology can produce particularly sharp distortions when taxes are raised primarily on affluent taxpayers, as they were under the 1990 and 1993 deficit reduction laws, and when, as at present, large increases in the stock market cause wealthy investors to reap huge capital gains profits and pay more capital gains taxes on them.
The Tax Foundation's methodology errs in other serious ways as well. For example, it counts as taxes items that clearly are not taxes, such as the optional premiums elderly and disabled people elect to pay for physicians coverage under Medicare. Of further concern, the Tax Foundation fails to count as income some of the income on which the taxes it counts are levied. For example, it counts capital gains tax payments as taxes but fails to count as income the capital gains income on which these taxes are levied. The methodological errors the Tax Foundation commits all distort its figures in the same direction they all make taxes look higher than they actually are.
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 assessing the Foundation's report, the following points merit consideration.
1. The federal tax burden the Tax Foundation says that families pay on average is 22 percent larger than the federal tax burden that CBO estimates the typical family bears and 51 percent larger than the federal tax burden the Joint Tax Committee estimates the typical family bears.
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 Congressional Budget Office 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. The Tax Foundation's estimates are more than one-fifth to one-half higher than the estimates of these more authoritative institutions.
2. 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 on this matter. O'Neill flatly stated 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."(2)
The fact that tax receipts have edged up as a share of GDP does not mean the typical middle-class family's taxes have increased, but that is precisely what the Tax Foundation's techniques assume. The Tax Foundation's methodology treats some of the increased taxes paid by high-income taxpayers as if those taxes were paid by the typical taxpayer, making it appear as though the average family has to work longer to pay its taxes than it does.
3. 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 the fifth of the population in the middle of the income spectrum pays 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 figure for 1998 will be somewhat lower because of the tax cuts.) This is not a trend toward higher federal taxes on middle-income families. The Tax Foundation itself acknowledged this point in a February 1998 release that received little coverage, 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."(3)
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.
4. 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. The principal state tax changes made last year, as well as those likely to be enacted this year, are tax cuts. The Tax Foundation's figure themselves indicate a fall in state and local taxes from 1997 to 1998.
5. The Tax Foundation's use of averages is severely flawed and substantially exaggerates middle-class tax bills.
In contending the average American must work until May to pay 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. The result is the percentage of income the Tax Foundation pictures the average American as paying in taxes, which the Foundation then converts into the percentage of the year the average American must work to satisfy his or her tax obligations. 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, for example, 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 than middle-class families do.
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. For example, the Tax Foundation 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.
This holds true for corporate income taxes, as well, which most economists (including those at CBO) believe are primarily passed through to the owners of capital assets, and for capital gains taxes paid on the sale of stocks, bonds, and real estate. The Tax Foundation 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.
Both Congressional Budget Office tables and Joint Committee on Taxation tables show that the average federal tax burden is higher than the federal tax burden that even the next-to-the-top income fifth pays (those between the 60th and 80th percentiles in income). These CBO and Joint Tax tables show how misleading it is to present the Tax Foundation's results as though they apply to families in the middle of the income scale.
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 fails to count all income. It 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. Yet federal income tax burdens on middle-income families are at their lowest levels in years. Moreover, the typical family would likely pay higher taxes under the proposed alternatives to the income tax.
The Tax Foundation's release of its study on April 15, the income tax filing date, may lead people to think federal income taxes are the main cause of the high tax burdens the Tax Foundation pictures the average family as facing. But only a small fraction of the taxes the Tax Foundation counts are federal individual income taxes. In fact, the CBO data indicate it will take only until January 23 for the typical household to pay its federal income taxes.(4)
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. The CBO data indicate the families in the middle of the income spectrum would have paid 6.3 percent of income in federal individual income tax this year if no tax cuts had been enacted in 1997.
Because of the tax cuts, income taxes for middle class families now are somewhat lower than that. Treasury Department analyses show that when the tax cuts enacted last year are taken into account, the percentage of income a typical family of four with two children and one working parent pays in federal individual income tax is now lower than in any year since 1959 except one.
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.
In fact, since affluent Americans pay a substantially 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 tax 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. Reduced revenue collections could usher in a new era of budget deficits or lead to large reductions in programs upon which the middle class relies.
The Tax Foundation's Methodology
For 1998, the Tax Foundation calculates the average tax burden as 35.4 percent and converts this figure into a statement that Americans must work 35.4 percent of the year until May 10 to pay their taxes.(5) This figure reflects an estimate that the average family pays 24.0 percent of its income in federal taxes and 11.4 percent of its income in state and local taxes. Both this estimate of the federal tax burden and the state and local tax figure significantly overstate the tax burden that the typical family bears.(6)
"Averages" versus "Medians"
The Tax Foundation's claim that the average American works until the first or second week of May to pay his or her taxes is a colorful way of describing an average effective tax rate. The average effective tax rate the percentage of income paid in taxes nationwide is simply total taxes divided by total national income.
In a tax system that is progressive that is, one in which higher-income people pay a larger share of their income in taxes than middle- and lower-income people an average effective tax rate gives disproportionate weight to the taxes wealthy people pay. For example, if four middle-income families pay $3,000, $4,000, $5,000 and $6,000, respectively, in taxes, and one 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 have a tax bill equaling $6,000 or less.
A much sounder approach is to examine the tax burdens of the median-income family the family whose income falls in the middle of the income distribution. The Congressional Budget Office and Joint Tax Committee figures cited here essentially reflect the taxes the median family pays.(7)
The problems created by using the average effective tax rate rather than the tax rate the median income family pays are further underscored when one considers capital gains and corporate income taxes. The Tax Foundation's methodology assumes that a taxpayer with income of $30,000 has the same share of its income consumed by capital gains and corporate income taxes as a taxpayer with income of $1 million or more. But this is not so.
Receipt of capital gains income profits derived from the sale of assets such as stocks, bonds, and real estate is disproportionately concentrated among those on the higher rungs of the income ladder. CBO analyses report that households with incomes in excess of $100,000 receive approximately three-quarters of all capital gains income. Similarly, most economists, including those at the Congressional Budget Office, believe that owners of corporations and related capital assets bear a disproportionate share of the federal tax on corporate profits and that such ownership also is concentrated among higher-income taxpayers. When the Tax Foundation computes an average tax rate, however, distinctions among types of taxes and the types of taxpayers that pay them are lost.
The degree to which the Tax Foundation's averaging approach produces skewed results is demonstrated by CBO and Joint Tax Committee tables. The tables show that prior to the enactment of last year's tax cuts, CBO projected that families in the middle fifth of the income distribution would pay 19.7 percent of their income in federal taxes in 1998. CBO projected that families in the next-to-the-top fifth would pay 22.7 percent of income in federal taxes. But when an average was computed by dividing total federal tax payments by total income the Tax Foundation's approach the CBO data showed 24.4 percent of income being paid in federal taxes. In other words, the "average" tax burden is higher than that paid not only by families in the middle of the income scale but even by families in the next-to-the-top income fifth. The Joint Committee on Taxation data show the same results.
Counting Items That Are Not Taxes
Another problem is that the Tax Foundation relies on Commerce Department data that include as government receipts a number of items that are not taxes. This reflects the fact that the Commerce data are not designed for use in calculating tax burdens; their purpose is to provide information on the total goods and services that make up the nation's Gross Domestic Product.(8)
The Tax Foundation's Response
In its April 15 press conference releasing its "Tax Freedom Day" report this year, the Tax Foundation sought to defend itself against criticism of its methodology by claiming its report does not purport to represent the average family's tax burden. Responding to the Center's critique that the Tax Foundation figures exaggerate the taxes paid by families in the middle of the income spectrum, the Tax Foundation issued a hand-out that stated "CBPP has asserted that Tax Freedom Day misleads the public by using the 'average family's' tax burden. This is simply incorrect. Tax Freedom Day establishes an overall benchmark showing the average tax burden for the nation as a whole."
This issue is an important one. As CBO and Joint Committee on Taxation data demonstrate, the Tax Foundation's average federal tax burden significantly exceeds the percentage of income that both families in the middle fifth of the income spectrum and families in the next-to-the-top fifth pay in federal taxes. Portraying the Foundation's figures as tax burdens that typical or average middle-class families pay is misleading.
But the "Tax Freedom Day" report the Tax Foundation issued April 15 does, once again, present Tax Freedom Day as representing the average American's tax burden, continuing the Tax Foundation's tradition of making middle-class tax burdens appear larger than they are. The second sentence of the Tax Foundation's April 15 press release reads: "The Tax Foundation projects that Americans on average would have to work 129 days to pay off their total tax bill this year..." (emphasis added). The lead paragraph of the accompanying Tax Foundation report contains essentially the same statement. In addition, the Foundation's press release declares that its report finds "that, since 1994, the tax burden borne by the average American has risen rapidly," (emphasis added) and it directs readers to a chart showing that Tax Freedom Day has come later in May every year since 1994. (In this year's report itself, the Foundation consistently uses the phrase Americans "on average;" last year the Foundation used the phrase "average American." This is a cosmetic change.)
That the Tax Foundation's report is widely understood as picturing the average American's tax burden is shown by an article on page one of the April 15, 1998 Wall Street Journal. The Journal, to which the Foundation leaked its report in advance, reported that "the Tax Foundation, a Washington non-profit research group, estimates the average taxpayer will have to work a record two hours and 10 minutes out of each eight hour workday this year [the May 10 date expressed as a fraction of an 8-hour work-day] merely to make enough to pay all federal, state, and local taxes."
The Tax Foundation also defended its Tax Freedom Day measure for providing a consistent measure over time, since it uses the same methodology every year. However, consistency in using a flawed methodology and failing to make needed corrections in the methodology is not a virtue.
Foundation State by State Data Also are Flawed
The Tax Foundation also issued on April 15 a list of the date that it says represent "Tax Freedom Day" for each state. These dates reflect the Foundation's estimate of the average tax rate in each state. The serious flaws that mar the Tax Foundation's estimates of tax burdens nationally, however, also render its state-by-state estimates invalid. About two-thirds of the tax burdens in the Tax Foundation calculations are federal tax burdens, which are substantially overstated in all of the Foundation's national and state-by-state calculations. In addition, as noted in this critique, the Tax Foundation's methodology for computing state and local tax burdens is seriously flawed and overstates those burdens as well.
- The Commerce data include as government receipts the premiums that most elderly people choose to pay to purchase Medicare Part B coverage (coverage for physicians' services) from the government. These premiums are no more a tax than any other voluntary purchase. Neither CBO nor OMB treats the income from these premiums as tax revenue.
- In the area of state and local government receipts, the Tax Foundation counts as taxes such items in the Commerce data as payments that private individuals or entities make for the rental of government property and fines that businesses pay for violating building codes or other local ordinances. Rental payments for the use of government space and fines for violations of health, safety, or other rules are not taxes.
- The Commerce data also include 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.
- Similarly, the Tax Foundation counts as government receipts the contributions that state and local government employees make to their own pension plans and the contributions that the governments make to those plans in their role as employers. These items are included as receipts in the Commerce Department data for technical accounting reasons. They are not taxes, and analysts who use the Commerce data to estimate state and local tax receipts do not count them as such.
The pension points require some elaboration. It is atypical for contributions to a pension plan made by an employee or an employer to be considered a tax. For example, the contributions that General Motors or any other company makes to a pension plan for its employees are not considered taxes; they, along with wages, are part of employee compensation. The contributions that private-sector employees make into their own retirement plans also are not counted as a tax. Employee contributions to private-sector pension plans are classified by the Commerce Department as personal savings.
The Tax Foundation contends these contributions should be counted as taxes because they are like Social Security payroll taxes, but the Tax Foundation's analogy to Social Security taxes is incorrect. Pension contributions to civil service retirement systems are most like the contributions that private employers make to private pension plans, which the Tax Foundation does not count as taxes. Moreover, in most states and for most federal workers, contributions to government pension plans are in addition to Social Security taxes, just as contributions to private employer pension plans are.
Of further note, the contributions that state and local governments make, in their role as employers, into employee pension funds are paid out of general revenues; those revenues have already been counted as taxes. So when the Tax Foundation counts government expenditures for pension contributions made on behalf of government workers as a tax, it is engaging in a clear case of double-counting. Taxes that governments collect from the public to finance government expenditures, including expenditures for pension contributions, are appropriately counted as taxes. But when these funds are then transferred from general government accounts to pension accounts, the Tax Foundation counts these funds as a tax again, inappropriately causing the same dollars to be counted as taxes twice.
As noted, the Commerce Department data series lumps funds transferred to federal, state or local government pension accounts in with government receipts. Analysts who use this Commerce Department data source to estimate state and local taxes (because it is more timely than other data sources) are aware of this quirk and are careful to exclude these fund transfers. (Analysts rarely use these Commerce Department data as a source of federal tax statistics, because more appropriate sources of information are readily available.) But whether unaware of these conventions or for some other reason, the Tax Foundation mistakably counts these government pension contributions as taxes.
Undercounting Family Income
In addition to overestimating the taxes that a median-income family pays and inappropriately counting as taxes various receipts that are not taxes, the Tax Foundation also undercounts family income. There is a mismatch between the broad types of taxes the Tax Foundation counts and the narrow base of income on which it assumes the burden of those taxes fall.
The Tax Foundation's treatment of the tax on capital gains income illustrates the problem. The income data the Tax Foundation uses do not include capital gains income. Nevertheless, the Tax Foundation counts the taxes paid on capital gains income as part of its measure of overall taxes. The effect is to overstate the percentage of income that taxes consume.
Consider the example of a family whose income equals $250,000, including $50,000 in capital gains. Assume the family's total tax bill, including its capital gains taxes, come to $70,000.
- If both capital gains income and taxes are considered, this family would be shown to pay 28 percent of its income in taxes ($70,000 divided by $250,000).
- By contrast, under the Foundation's approach which counts capital gains taxes but not capital gains income the family's tax burden would be calculated as 35 percent ($70,000 divided by $200,000).
Discrepancies between Tax Foundation Claims and CBO and Joint Tax Committee Estimates
The Tax Foundation's statement that taxes absorb 35.4 percent of family income includes an estimate that families pay 24 percent of their income in federal taxes. Data from CBO and the Joint Committee on Taxation cast serious doubt on this estimate.
- The respected, non-partisan Congressional Budget Office has reported that the federal tax burden on families in the middle fifth of the income distribution equaled 19.7 percent of income before the effects of the 1997 Taxpayer Relief Act are taken into account, rather than 24 percent. Compared to the CBO findings, the Tax Foundation's estimate exceeds the federal tax burden of the typical, or median-income, family by more than one-fifth.
- The Joint Committee on Taxation (JCT), the tax estimating arm of Congress, finds that families in the middle of the income distribution pay 15.9 percent of their incomes in federal taxes. The Tax Foundation estimate exceeds the Joint Committee's estimate of the federal taxes the typical family pays by more than half. (The JCT figure is lower than CBO's primarily because the Joint Committee uses a broader definition of income than CBO. The Joint Committee's estimate also is lower than CBO's because the Joint Committee does not include the effects of corporate income taxes, although that reason is not as important as the Joint Committee's use of a broader definition of income. Excluding corporate taxes would have a major impact on the tax burdens of high-income families, but this is not the case for median-income families; median-income families do not bear much corporate income tax as they do not have much capital income.)
As noted, the Tax Foundation assumes the state and local tax burden to be 11.4 percent of income. This figure represents a decline from the Foundation's 1997 estimate of 11.8 percent. The Tax Foundation derived this figure from a Commerce Department data series that includes various items that are not taxes, such as the contributions that state and local government employees make to their own pension plans.
For the 1997 estimate, the Center on Budget and Policy Priorities adjusted these data to exclude the items that are not taxes. After this adjustment, the average state and local tax burden in 1997, based on the Commerce Department data the Tax Foundation favors, would have been 10.1 percent of income rather than the 11.8 percent figure in the Foundation's 1997 Tax Freedom Day report.
A more accurate estimate of the overall federal, state, and local tax burden for a median-income family can be derived by combining the Congressional Budget Office or Joint Committee on Taxation estimate of the federal tax burden a family in the middle of the income spectrum bears with the average state and local tax burden that can be derived from the Commerce Department data after removing the non-tax items.
- Using the CBO estimate of the federal tax burden, the combined federal, state, and local tax burden for a median-income family would be approximately 29.8 percent of income before considering the effects of the 1997 tax reductions. (This equals CBO's 19.7 percent estimate of the federal tax burden plus the 10.1 percent estimate cited above for the state and local tax burden.)
- Using the Joint Committee on Taxation tax estimate of the federal tax burden, the combined federal, state, and local tax rate for a median-income family would be approximately 26 percent before considering the effects of the 1997 tax reductions. (This equals the Joint Committee's 15.9 percent federal tax burden figure plus the 10.1 percent state and local tax burden estimate.) Both of these estimates are well below the Tax Foundation's estimates.
Changes Over Time in the Taxes that Typical Middle-Income Families Pay
While taxes as a percentage of income fluctuate from year to year, the trend over the past two decades has, as noted, been remarkably stable. CBO analyses show that the federal taxes paid by the 20 percent of families in the middle of the income scale equaled 20 percent of income in 1979 and were estimated to equal 19.7 percent income in 1998 prior to passage of last year's tax-cut legislation.
A Treasury Department analysis gives some indication of current federal income tax burdens in the aftermath of last year's tax legislation. The analysis indicates that when the tax cuts enacted last year are taken into account, 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 1959 except one.(9)
The long-term trend for state and local taxes also is relatively stable. The Commerce Department data, adjusted to remove the receipts that are not taxes, show that average state and local taxes equaled 10.1 percent of national income in both 1997 and 1977. In no intervening year during the past two decades did state and local taxes fall below 9.3 percent of income or rise above 10.3 percent of income. The Tax Foundation figures themselves suggest a modest decline in state and local tax burdens from 1997 to 1998.
Tax Levels versus Expenditures on Food, Shelter and Housing
Tax Foundation reports consistently state that families must pay more in taxes than they pay for food, clothing, and shelter combined.
This Tax Foundation claim is a further illustration of the problems with using aggregate figures on total tax payments, total payments for food, and the like. Even if the statement that total tax payments exceed total expenditures for food, clothing and housing is accurate, that tells us little about the relationship between taxes and spending for families in the middle of the income scale. It is no doubt true that upper-income families pay more in taxes than they do for basic necessities. At the same time, it also is true that low- and moderate-income families pay less in taxes than they spend for basic necessities; necessities consume most of their income. The precise family income level at which taxes typically exceed expenditures for food, clothing and housing is unclear, and the Foundation's report does not help to answer that question.
Furthermore, while Americans spend a smaller proportion of their incomes on food, clothing, and housing than they used to, this is not because they are paying more in taxes. Rather, it is because the share of after-tax expenditures devoted to food, shelter, and clothing has shrunk significantly, while the share devoted to costs for items such as health care has risen. In 1970, some 44 percent of after-tax expenditures went for food, clothing and shelter. That figure has declined to about 34 percent today. A drop in the share of expenditures going for food accounts for most of the decline.
Changes in Revenues as a Percentage of GDP
The claims the Tax Foundation makes about taxes being at an all-time high have been echoed in recent months by a number of Members of Congress and commentators who cite a CBO estimate that federal revenues now equal 20 percent of the Gross Domestic Product and note this is the highest level since the end of World War II. This CBO figure, however, is not an estimate of the federal tax burden of the typical family. There are critical differences between measuring federal revenues as a share of the economy and measuring the typical family's tax bill as a share of its income.
As mentioned earlier, CBO director June O'Neill testified recently that tax receipts have increased as a share of GDP in the last few years largely because of robust income gains among high-income families, in part reflecting the large jump in their capital gains income. This increase in the taxes paid by high-income families has helped boost federal revenues as a share of GDP, but it has no effect on the percentage of income the typical family in the middle of the income scale pays in federal taxes.
Nor does the 20 percent-of-GDP figure mean the federal government has grown and become bigger than ever. During every year from 1975 through 1996, federal expenditures exceeded 20 percent of GDP while federal revenues were below this level. It was this imbalance that produced the budget deficits of this period.
While federal revenues have risen as a share of GDP in recent years, federal expenditures have declined as a share of GDP, indicating the federal government has become a little smaller in relation to the economy. In fact, the decline in federal spending has been a larger factor in erasing the deficit over the past decade than the rise in revenues. Federal spending as a percentage of GDP is currently 2.4 percentage points lower than its average level in the 1980s. Federal receipts as a percentage of GDP are 1.7 percentage points above the average 1980s level.
The share of GDP that consists of federal revenues is projected to decline modestly over the next few years, partly as a result of the 1997 tax legislation. A number of the tax cuts in the 1997 law phase in gradually or do not take effect for several years. As a result, taxpayers will effectively experience new tax cuts each year for the next few years, and revenues will edge down as a share of GDP. CBO projects revenue will decline to 19.4 percent of GDP in 2002 and 19.3 percent in 2003 and succeeding years.
Working for the Government Rather than Yourself
The Tax Foundation has characterized Tax Freedom Day as the point at which average taxpayers "can begin working for themselves." This characterization implies that taxpayers receive nothing back from the payment of taxes.
It is worth remembering that payroll taxes pay for the Social Security checks and health insurance coverage under Medicare for the nation's elderly and disabled. Local, state, and federal taxes pay for schools, roads, parks, police officers, firefighters, and air traffic controllers. Federal taxes pay for the defense of our freedom, and more prosaically for clean food, air, and water.
How Do Tax Levels in the United States Compare to Levels in Other Countries?
International data on the tax burden of the typical family are not available, but there is information available on the size of overall tax revenues as a share of the economy. This information comes from the Organisation for Economic Co-operation and Development, one of the most respected sources of data for international comparisons. OECD compiles and analyzes economic data for its member nations (mostly western, industrialized nations).
The OECD data indicate that out of 29 countries examined, only three (Korea, Mexico, and Turkey) collect a smaller share of revenues as a percentage of the economy than the United States does.* In other words, taxes are lower as a share of the economy in the United States than in nearly all comparable nations, including countries such as Canada, Germany, and the United Kingdom. Taxes in the United States as a share of the economy are one-quarter lower than taxes are, on average, in the other countries examined.
*Organisation for Economic Co-operation and Development, Revenue Statistics 1965-1996, 1997.
They also cover programs that provide some support if, for example, a person suffers a permanently disabling accident, mental illness, or other misfortunes of life i.e., programs such as unemployment insurance, disability benefits, Medicaid, and federal assistance following natural disasters. While some Americans may never need these programs themselves, many have family members who will need them at some point. To some degree, the taxes that support programs such as these are like premiums paid for fire or automobile insurance; the insurance can be worth buying even if an individual does not collect on it.
The increase in federal revenues in recent years which, as noted, stems overwhelmingly from increased tax payments by higher-income people also has served another purpose. This revenue has helped to eliminate the federal deficit, a positive development for Americans that has contributed to low interest rates, low inflation, and sustained economic growth.
Increasingly, the Tax Foundation's figures are being used to justify sweeping proposals to scrap the federal income tax code. As noted, however, only a modest portion of the taxes that the Tax Foundation claims the average American is paying are federal income taxes. Due to its progressive nature, the federal income tax is one of the least burdensome taxes on middle-class families.
Some flat tax or sales tax advocates use the impression the Tax Foundation's reports convey that middle-class families are shouldering crushing federal income-tax burdens to push for replacing the progressive income tax. This is ironic; since flat tax or sales tax proposals necessarily result in large tax reductions for the well-to-do, such proposals must raise taxes on middle-class families to be revenue-neutral.
The income tax does need reform in certain important respects. The tax code is too complicated, especially after last year's federal tax legislation, which made it more intricate. Tax reform could make the code simpler and fairer. Paring back special-interest tax provisions could clean up the code and allow somewhat lower tax rates. The 1986 Tax Reform Act, approved with strong bipartisan support, showed reform of this nature is feasible. State and local taxes also could be made more equitable for typical, middle-class families. That could be accomplished through greater reliance on progressive income taxes and less reliance on regressive sales and property taxes that consume a larger proportion of the income of middle-income and poor families than of high-income families.
Estimated Effective Federal Tax Rates by Quintile
for 1998 (Before 1997 Law Changes Were Adopted)
Congressional Budget Office
Joint Committee on Taxation
Average for All Taxpayers 24.4%
Sources: Congressional Budget Office, May 15, 1997 and Joint Committee on Taxation, June 24, 1997.
CBO defines pre-tax family income as the sum of wages, salaries, self-employment income, rents, taxable and non-taxable interest, dividends, realized capital gains, and all cash transfer payments. Income also includes the employer share of Social Security and federal unemployment insurance payroll taxes, and the corporate income tax. For purposes of placing families into quintiles, CBO adjusts for family size; it divides the income for each family by the poverty threshold for a family of that size. The Joint Committee defines income as adjusted gross income (AGI) plus tax-exempt interest, employer contributions for health plans and life insurance, the employer share of Social Security, workers compensation, nontaxable Social Security benefits, the insurance value of Medicare benefits, alternative minimum tax preference items, and excluded income of U.S. citizens living abroad.
The federal taxes that the CBO analysis includes are individual income taxes, employer and employee shares of payroll taxes, excise taxes, and corporate income taxes. The federal taxes the JCT analysis includes are individual income taxes (including the outlay portion of the EITC), employer and employee shares of payroll taxes, and excise taxes.
CBO Estimates of Effective Federal Tax Rates for 1998,
Prior to Enactment of Last Years Tax Cuts
Families Ranked by Income Quintile
Individual Income Tax
Social Insurance Taxes
Corporate Income Tax
Total Federal Taxes
Lowest -6.9% 7.8% 0.5% 2.8% 4.2% Second 1.7% 9.9% 0.9% 1.6% 14.2% Third 6.3% 10.8% 1.4% 1.2% 19.7% Fourth 9.0% 11.3% 1.4% 1.0% 22.7% Highest 16.2% 8.0% 4.6% 0.5% 29.3% Top 10% 18.0% 6.7% 5.8% 0.4% 30.8% Top 5% 19.7% 5.3% 7.0% 0.3% 32.3% Top 1% 23.0% 3.0% 9.5% 0.2% 35.7% Average for all families 11.2% 9.3% 3.0% 0.9% 24.4% Source: Congressional Budget Office, May 15, 1997.
Notes: Pre-tax family income is the sum of wages, salaries, self-employment income, rents, taxable and non-taxable interest, dividends, realized capital gains, and all cash transfer payments. Income also includes the employer share of Social Security and federal unemployment insurance payroll taxes, and the corporate income tax. For purposes of ranking by adjusted family income (AFI), income for each family is divided by the poverty threshold for a family of that size. Quintiles contain equal numbers of people. Families with zero or negative income are excluded from the lowest income category but included in the total.
Individual income taxes are distributed directly to families paying those taxes. Payroll taxes are distributed to families paying those taxes directly or indirectly through their employers. Federal excise taxes are distributed to families according to their consumption of the taxed good or service. Corporate income taxes are distributed to families according to their share of capital income.
Effective Federal Tax Rates for 1998
Joint Committee on Taxation Estimates
Before Enactment of Last Years Tax Cuts
Percentage of Income Paid
in Federal Taxes2
Lowest 6.0% Second 10.5% Third 15.9% Fourth 18.6% Highest 25.0% Highest 10% 26.5% Highest 5% 27.6% Highest 1% 30.2% Average for all Taxpayers 20.2%
Source: Joint Committee on Taxation, June 24, 1997.
1 The income concept used to place tax returns into income categories is adjusted gross income (AGI) plus: (1) tax-exempt interest, (2) employer contributions for health plans and life insurance, (3) employer share of FICA tax, (4) workers compensation, (3) nontaxable Social Security benefits, (6) insurance value of Medicare benefits, (7) alternative minimum tax preference items, and (8) excluded income of U.S. citizens living abroad.
2 Federal taxes are equal to individual income tax (including the outlay portion of the EIC), employment tax (attributed to employees), and excise taxes (attributed to consumers). Corporate income tax is not included due to uncertainty concerning the incidence of the tax. Individuals who are dependents of other taxpayers and taxpayers with negative income are excluded from the analysis.
1. Patrick Fleener and Scott Moody, "Tax Freedom Day 1998 is May 10," The Tax Foundation, April 1998.
2. June E. O'Neill, The Economic and Budget Outlook: Fiscal Years 1999-2008, Testimony before the Senate Budget Committee, January 28, 1998.
3. Tax Foundation, Family Tax Burdens 20 Years Later, Revisited, February 5, 1998.
4. CBO estimates that before taking into account the tax cuts enacted last year, families in the middle fifth of the income spectrum would owe 6.3 percent of their income in federal individual income taxes in 1998. This is equivalent to 23 out of the 365 days of the year.
5. Last fall, the Foundation issued another press release contending the typical two-earner family pays 38 percent of its income in taxes. The 38 percent figure, which has been cited by some prominent political leaders, is derived through a methodology that contains many of the same flaws as those described here. The 38 percent figure in this other Tax Foundation report is higher than the figure reflected in the Foundation's "Tax Freedom Day" report primarily because the 38 percent figure is derived from calculations based only on two-earner families. Two-earner families tend to have higher total family income, and thus to pay a larger percentage of their income in taxes, than families overall. The methodological shortcomings in the Tax Foundation's report that contains the 38 percent figure are reviewed in Iris Lav's "The Debate Over Tax Levels: How Much Does A Typical Family Pay?" Center on Budget and Policy Priorities, March 11, 1998.
6. Much of this section of this paper, as well as other parts of the paper, are drawn from the analysis by Iris Lav cited in the previous footnote.
7. In most cases, the CBO and Joint Tax Committee figures used here reflect the average tax burden for the middle fifth of the population. The average tax burden for the middle fifth of the population is slightly higher than the tax burden on the median household (that is, the CBO and Joint Tax figures slightly overstate the tax burden for the typical family), but this overstatement is far smaller than the overstatement that occurs when the average tax for all families is used as a proxy for the taxes the typical family pays.
8. These Commerce Department data are from the National Income and Product Accounts, which are designed to display the value and composition of national output not to compute tax burdens. The Gross Domestic Product figure is derived from these accounts, as is the Net National Product.
9. Office of Tax Analysis, Department of the Treasury, January 15, 1998. In the Treasury analysis, family income is assumed to be at the median income for four-person families, which Treasury estimates to be $54,900 in 1999. Income is assumed to come entirely from wages and salaries and be earned by one spouse. The family is assumed to have two children eligible for the new child tax credit. This is an example of a particular kind of family rather than being representative of all median-income families.
Additional tax analyses can be viewed in our library.