March 11, 1998
The Debate Over Tax Levels:
How Much Does a Typical Family Pay?
by Iris J. Lav
A major debate now is taking place over whether the typical American family pays too much of its income in taxes. Some pundits and policymakers have decried tax levels they claim have been rising rapidly and have reached 38 percent of income for the typical family. This has lead some of them to conclude that radical reform of the federal tax system and steep reductions in the size of government may be required to lower tax burdens.
Among those who have cited the 38 percent figure is Senate majority leader Trent Lott. In his response to the President's State of the Union address, Senator Lott declared: "The typical family pays more than 38 percent of its income in taxes. That's nearly 40 cents of every dollar. That's not just bad policy. It's immoral."
But it also is not accurate. The source of these claims is a November 1997 report of the Tax Foundation, which states that the combined federal, state, and local tax burden for a family at the median income level for all two-earner families was 38.2 percent in 1997, up from 37.3 percent of income in 1996. The Tax Foundation figure, however, is sharply at odds with information on tax burdens from more authoritative sources, including the Congressional Budget Office and the Joint Congressional Committee on Taxation.
- A measurement of tax burdens that relies on Congressional Budget Office and Joint Committee on Taxation data to estimate the median family's federal tax burden would find the median-income family is paying between 26 percent and 30 percent of its income in federal, state and local taxes, not 38 percent. Moreover, this 26 percent to 30 percent figure does not take into account the effects of the 1997 federal tax law, which is lowering the effective federal tax rate of the typical family.
- Data from CBO and other sources also show that the tax burdens of median-income families have been relatively stable over the past two decades. These tax burdens are neither at all-time highs nor escalating rapidly.
The Tax Foundation's statement that taxes absorb 38.2 of a median two-earner family's income includes an estimate that this median family pays 26.2 percent of income in federal taxes. Data from CBO and Joint Committee on Taxation data cast grave doubt on that 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, not 26.2 percent. Compared to the CBO findings, the Tax Foundation has overstated the federal tax burden of the typical, median-income family by nearly one-third. (See Table 1.)
- 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. Relative to the Joint Committee on Taxation analysis, the Tax Foundation overstates the federal tax burden of the typical, median-income family by more than 60 percent. (The JCT figure is lower than CBO's for two reasons: the Joint Committee uses a broader definition of income than CBO, and it does not include the effects of corporate income taxes. Although the lack of inclusion of corporate taxes would have a major impact on the tax burden of high-income families, 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.)
The Tax Foundation also assumes that the state and local tax burden of the median-income two-earner family equals 12.1 percent of income. This figure is overstated as well. The source for it is a Commerce Department data series that is intended to be used to measure total economic activity, not tax burdens. The data series includes various items that clearly are not taxes, such as the contributions that state and local government employees make to their own pension plans. This data series also includes such non-tax items as rent that private entities pay for space a state or local government owns and fines that businesses pay for violating local codes or regulations, such as building codes. The Tax Foundation fails to distinguish between those items in the Commerce data series that are state and local taxes and those that are not, inappropriately counting these various non-tax items as taxes and including them in figuring the median family's tax burden. If an adjustment is made to exclude the items that are not taxes, the average state and local tax burden, based on the Commerce Department data the Tax Foundation favors, would be 10.1 percent of income, not 12.1 percent.
Estimated Effective Federal Tax Rates by Quintile
for 1998 (Before 1997 Law Changes Were Adopted)
Income Quintile Congressional Budget Office Joint Committee on Taxation
25.0% All Taxpayers
20.7% 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, worker's 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.
Moreover, the Commerce Department data series the Tax Foundation uses has limitations for determining state and local tax burdens that go beyond the inclusion of non-tax receipts. These data include state capital gains taxes paid on profits from the sale of assets. But these data do not include, in their measure of income, the capital gains income on which these taxes are paid. Counting taxes while failing to count the income on which the taxes are paid makes tax burdens appear higher than they actually are.
A more accurate estimate of the overall federal, state, and local tax burden for a median-income family can be made by combining the Congressional Budget Office or Joint Committee on Taxation estimate of the federal tax burden that a family in the middle income quintile bears with the average state and local tax burden derived from the Commerce Department data, after removing the non-tax items from the data. (The Commerce data cannot be adjusted to correct for the problem of counting state capital gains taxes without including the capital gains income on which these taxes are based.)
- Using the CBO analysis to determine 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 19.8 estimate of the federal tax burden plus the 10.1 percent estimate cited above for the state and local tax burden when non-tax items are removed from the Commerce data. Relative to this measure, the Tax Foundation figure of 38.2 percent overstates the tax burden by 28 percent.
- Using the Joint Committee on Taxation tax analysis to estimate 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. Relative to this measure, the Tax Foundation figure overstates the combined tax burden by 47 percent.
The median-income family's tax burdens have been relatively stable over the past two decades. While effective tax rates fluctuate somewhat from year to year, there is no evidence of a trend toward higher taxation of such families.
- The CBO analysis shows that the federal taxes the fifth of the population in the middle of the income spectrum pays consumed 20.0 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. As a result of those tax cuts, the figure for 1998 should be a little lower. The federal tax burdens that median-income families face thus are a little lower than they were two decades ago.
The Tax Foundation itself made a similar point in February 1998 news release that has received far less attention than its November report. The more recent release 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."(1)
- The Commerce Department data that indicate state and local taxes equaled approximately 10.1 percent of income in 1997 show the figure was exactly the same 10.1 percent 20 years earlier in 1977. The constant tax level is striking in the face of the additional responsibilities states and localities have had to assume over this period.
What caused the Tax Foundation's figures to be so high? The Tax Foundation overstates the taxes a median-income family pays and also understates the income on which these taxes are based. Serious methodological problems cause the Tax Foundation's analysis to overstate the typical family's tax burdens.
- The Tax Foundation assumes that all families, regardless of income, pay the same percentage of income in federal corporate income taxes and estate taxes. Its methodology assumes that a median-income 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. This, of course, is not the case. Most corporate income taxes and virtually all estate taxes are paid by high-income taxpayers. Estate taxes are paid only on the estates of the wealthiest two percent of decedents; the other 98 percent of estates are exempt. In addition, most economists, including those at the Congressional Budget Office, believe both that the federal tax on corporate profits ultimately is paid by individuals who hold capital assets such as stocks, bonds, or other forms of capital and that ownership of capital is concentrated among higher-income taxpayers. While middle-income families generally have some capital assets, the assets held by middle-income families are a small fraction of the total capital assets in the economy.
The Tax Foundation computes average tax rates for corporate income taxes and estate taxes and applies these average rates to median-income families and wealthy families alike. This averaging method assigns a much larger amount of federal corporate income taxes and estate taxes to a median-income family than such a family actually pays.
- In addition, as noted above, the Commerce Department data that the Tax Foundation uses to calculate state tax burdens include, as state and local government receipts, a number of items that are not taxes. As also noted, the Commerce data include capital gains taxes that families pay while failing to include the capital gains income on which these taxes are based.(2)
Even under its own methodology, the Tax Foundation made an error in deriving the state and local tax burden of its median two-earner family. The Tax Foundation assumed an increase in state and local taxes between 1996 and 1997 that is not supported by the Commerce Department data upon which the Tax Foundation relies. The Commerce data show the state and local tax burden declined between 1996 and 1997, rather than rising.(3)
In addition to these methodological problems is an overarching problem created by the mismatch between the types of taxes the Tax Foundation counts and the income on which it assumes the burden of these taxes fall. The Tax Foundation attempts to count comprehensively all types of taxes levied at all levels of government. It then applies these taxes to a hypothetical median-income family that it specifies receives 96 percent of its income from wages. If such a family pays all of the taxes that the Tax Foundation assigns to it, however, it is not possible for the family to receive as much as 96 percent of its income from wages.
Revenues as a Percentage of GDP: What Do the Figures Mean?
In recent weeks, some Members of Congress and some commentators have cited a CBO estimate that federal revenues now equal about 20 percent of the Gross Domestic Product the basic measure of the size of the economy and have observed that this is the highest level since the end of World War II. Such statements should not lead, however, to the conclusion that the typical family's tax burdens are at a post-World War II high.
There are important 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 CBO director June O'Neill recently testified, tax receipts have risen as a share of GDP 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."* These developments do not significantly affect the percentage of income that the typical, median-income family pays in federal taxes.
The 20 percent-of-GDP figure also does not mean the federal government has grown and become bigger than ever. Federal expenditures exceeded 20 percent of GDP every year from 1975 through 1996. Federal revenues have been below this level, and this imbalance caused the budget deficits we experienced.
Although 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 consisting 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 reductions in the 1997 tax 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 that revenue will decline to 19.4 percent of GDP in 2002 and 19.3 percent in 2003 and succeeding years.
*Statement of June E. O'Neill, Director, Congressional Budget Office, before the Senate Budget Committee, January 28, 1998.
The issue of corporate taxes illustrates the problem. Economists generally agree that individuals ultimately pay corporate income taxes. They also agree that in calculating a tax burden, it is necessary to distribute to individuals both the corporate taxes and the corporate income on which those taxes are based. The Tax Foundation, however, neglected to count this income. The Tax Foundation report attributed taxes to median-income families without attributing to them the appropriate amount of income the families would need to have to owe these taxes. This is another reason the Tax Foundation finds tax burdens to be so much higher than do more widely respected and authoritative institutions and researchers.
The Tax Foundation Report
In November 1997, the Tax Foundation issued a report entitled "Tax Burden on American Families Rises Again." The lead paragraph of the report states: "In 1997, the tax burden on America's median income families increased again. This year federal, state and local taxes combined are projected to claim 38.2 percent of the income of a median income two-earner family, up from 37.3 percent in 1996. For a single-earner family, total taxes as a percentage of income are projected to increase to 35.6 percent, up from 35.5 percent last year."
This report has figured in the debate over taxes and the size of government, and it has been cited by many pundits and policymakers. Specifically, the report's figure for the tax burden of the median-income two-earner family has been widely cited as applying to the "typical" American family; Senator Lott's statement that "the typical family pays more than 38 percent of its income in taxes" is an example of this. Similarly, in The Wall Street Journal, Steve Forbes wrote, "Combined with state and local taxes, average middle-class families now pay nearly 40% of their income in taxes."(4) In addition, USA Today reported earlier this year that "House Speaker Newt Gingrich, R.-Ga., said Monday that the government should commit to capping total taxes federal, state and local to not more than 25% of income, compared with 38% now."(5)
Even if the Tax Foundation were correct in its assessment of the taxes a median-income two-earner family pays, the use of the tax burden of a family at the median income for a two-earner family to represent the typical family in general would result in an overstatement of the typical family's taxes. In 1996, the median income for families with two workers was $52,416; this was 48 percent higher than the median income for all families, which stood at $35,492.
In our progressive tax system, higher-income families pay a larger percentage of income in taxes than do lower-income families. Even without considering the methodological flaws in the Tax Foundation's calculations, the focus on a two-earner family produces estimates of a somewhat higher tax burden than the typical family pays.
This focus on the dual-earner family is, however, only one of a number of reasons the Tax Foundation's 38 percent tax burden figure substantially exceeds the 26 percent to 30 percent estimate that analyses based on CBO and Joint Committee on Taxation data would support. For example, the Tax Foundation estimates that a family at the median income for single-earner families pays 35.6 percent of income in taxes, a percentage still well above the range the CBO data and Joint Committee on Taxation data support. Yet the Tax Foundation assumes this single-earner family has income of just $28,808. As this suggests, an array of methodological problems account for the bulk of the difference between the Tax Foundation estimate and estimates based on the analyses of more authoritative institutions.
The principal methodological problems with the Tax Foundation's tax burden calculations fall into three categories: overestimating the taxes the median-income family pays through inappropriate use of average tax burdens; counting as taxes some items included in government receipts data that are not taxes; and undercounting family income. Each of these problems biases the measurement in the same direction, toward a finding of a higher tax burden than is actually the case.
Use of Average Tax Burdens
The Tax Foundation report uses a hybrid methodology to calculate the tax burdens of its median-income families. The Foundation begins by creating hypothetical median-income families based on Census data on family income. For federal personal income taxes and payroll taxes, the Tax Foundation study then computes the taxes these hypothetical median-income families pay in a straightforward manner. For all other taxes, however, it uses an averaging procedure that is fraught with methodological problems.
For federal personal income taxes, the Tax Foundation uses IRS statistics to determine the effective tax rate for a married taxpayer at the designated income level. For the payroll tax computation, it applies the tax rate for both the employee's and the employer's share of the tax to the amount of the family's wage income. This is standard procedure for computing tax burdens, because it is generally accepted that employees in effect pay the employer portion of payroll taxes in the form of reduced wages.
The Tax Foundation report also follows the generally accepted procedure of adding the amount of the employer's share of payroll taxes to the employee's income as though the wages had not been reduced. This results in an appropriate matching of the taxes paid to the income on which the taxes are levied. (As noted below, the Tax Foundation mistakenly fails to follow this procedure with respect to various other types of taxes, such as corporate income taxes; although the Tax Foundation assumes that a portion of corporate income taxes reduces wages, and therefore constitutes a tax on median-income families, it fails to attribute to these families a corresponding amount of corporate income.)
For all taxes in its report other than federal personal income taxes and payroll taxes, the Tax Foundation uses a very different approach. The Tax Foundation computes the average tax rate for all other types of taxes. It does so by dividing total tax payments for the type of tax being considered by the Net National Product, the measure it uses for national income in this part of its calculations.(6) The Tax Foundation then assumes its median income families pay these average tax rates.
The Tax Foundation uses this averaging procedure to derive a figure for the tax rate for four principal types of federal taxes corporate income taxes, estate and gift taxes, excise taxes, and customs duties. Federal corporate income and estate taxes together account for more than 85 percent of the federal taxes to which the Tax Foundation applies this procedure.
When the Tax Foundation applies this averaging method, it makes the assumption that all families, regardless of income, pay the same percentage of income in these taxes. Thus, the Tax Foundation effectively assumes that a family with an income of $50,000 pays the same percentage of income in corporate and estate taxes as a wealthy family with income of $5 million and extensive investments.
But that is not the case. Corporate income taxes and estate taxes are largely borne by taxpayers with incomes much higher than the median-income family. The Tax Foundation's averaging procedure overstates the amount of estate and corporate income taxes a median family pays.
Estate taxes are paid solely on the estates of the wealthiest two percent of decedents, as the federal estate tax exemption eliminates taxation for the other 98 percent of estates.(7) The Tax Foundation methodology mistakenly assumes median-income families pay the same proportion of their incomes in estate taxes as wealthy families do.
Corporate income taxes also are largely paid by wealthier families and do not have a substantial impact on the tax burden of the median-income family. Most economists believe the federal tax on corporate profits ultimately is paid by the individuals who own corporations that is, those who hold capital assets such as stocks, bonds, and other forms of capital. The ownership of capital is concentrated among higher-income taxpayers. Middle-income families do generally have some capital assets, but the assets that these families hold are a small fraction of the total capital assets in the economy. Research has found that the highest-income fifth of Americans held 84 percent of the nation's wealth in 1992, while the middle fifth where the median-income family would be found held 4.4 percent of the nation's net assets.(8) Despite this concentration, the Tax Foundation's averaging methodology assumes that a taxpayer making $50,000 pays the same percentage of income in corporate income tax as a taxpayer with a $1 million or $10 million income and widespread investments.
Furthermore, other aspects of the Tax Foundation's own calculations implicitly acknowledge that median-income families derive little of their income from capital asset holdings. The Tax Foundation report assumes median-income families receive 96 percent or 97 percent of their income from wages,(9) with the remaining three percent or four percent of income apparently coming from sources such as Social Security, unemployment insurance, and veterans benefits, along with a small amount of interest and dividend income.(10) The Tax Foundation's calculations do not assume that median-income families derive significant income from corporate profits.
The Tax Foundation's assumptions about family income thus are inconsistent with its assumption that the median-income family pays the same percentage of its income in corporate income taxes as a wealthy family does. The Tax Foundation assumes both that a median-income family derives nearly all of its income from wages and that it has enough capital income and investments to pay the same share of its income in corporate taxes as would a millionaire with extensive asset holdings.(11) Both assumptions cannot simultaneously be true.
Average Tax Burdens and State and Local Taxes
The Tax Foundation uses this same type of averaging procedure to compute all of the state and local taxes its median-income families are said to pay. The Tax Foundation consequently assumes that the median-income family bears an average share of state corporate income taxes and estate and inheritance taxes. It is unclear whether using an average tax rate for all state and local taxes results in the same type of significant distortion of median-family tax burdens that this methodology causes when applied to various federal taxes. State and local taxes include both progressive taxes, such as individual and corporate income taxes and estate taxes, and regressive sales taxes and excise taxes. As a result, there probably is not a large difference between the average percentage of income paid in state and local taxes and the percentage of income that a median-income family pays.
There is one way, however, in which the averaging procedure causes a distortion of state and local tax burdens. Most states and some cities such as New York City levy personal income taxes that, like the federal income tax, include taxation of capital gains income. The problem here is that state and local capital gains taxes are included in the receipts component of the Commerce Department data series the Tax Foundation uses, but the capital gains income on which these taxes are levied is not included in the income component of this data series. The Tax Foundation's calculations thus fail to match the taxes it includes in the numerator of its tax burden measure to the measure of income used as the denominator. Counting taxes without counting the income on which the taxes are paid makes the percentage of income the median family pays in state income tax appear higher than it really is.(12)
Avoiding this type of error is particularly important in today's economy. Most states as well as the federal government are reporting surges in taxes on capital gains income as a result of the unusually strong performance of the stock market and the newly lowered federal capital gains tax rate that took effect last year. If total taxes, including surging capital gains taxes, are divided by a measure of income that fails to include capital gains income, tax rates will appear both to be higher and to be rising faster than is actually the case.
Counting Items That Are Not Taxes
Still another problem is that the Commerce data include as state and local government receipts a number of items that are not taxes. The Commerce data are not designed to be used to calculate tax burdens but rather to compile information on the total goods and services that make up the nation's Gross Domestic Product.(13) The Commerce Department data series includes data that differ from those one would use to compute a tax burden.
For example, the Commerce Department measure the Tax Foundation uses to derive its estimate of state and local tax burdens includes a category listed as "contributions for social insurance." The major component of this category consists of contributions that state and local government employees, and state and local governments as their employers, make to government employee retirement accounts. For the employee, these contributions are a form of personal savings he or she will receive back, with earnings, upon retirement. Should the employee cease working for the government before retirement, he or she generally is entitled to a return of these contributions. The contributions that government employees make to their own pension plans are analogous to the pension contributions that employees in the private sector make. They are not taxes.
The contributions that governments as employers make to employee pension plans also are not taxes. They are government expenditures for employee compensation. For technical reasons, the Commerce Department accounts include both as a receipt and as an offsetting outlay the transfer of government funds from general accounts to pension fund accounts. But a transfer of funds from a general government account to a pension account does not represent an additional tax, and it should not be counted as part of families' tax burdens.
Moreover, counting the transfer of such funds from one government account to another as an additional tax, as the Tax Foundation apparently does, is a clear case of double-counting. The 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, causing the same dollars to be counted as taxes twice.
The Tax Foundation appears also to count other portions of state and local government receipts that are not taxes.(14) These include those portions of the broad "indirect business taxes" category included in the Commerce data series that consist of items such as fines collected from businesses and receipts from the rental of government property. The fines result from local and state enforcement of regulations such as building codes and from assessments such as penalties for the late filing of business license permits. These are penalties for violation of particular laws, not taxes. Similarly, receipts from the rental of government property to private parties are rent payments, not taxes.
The November 1997 Tax Foundation report stated that the average state and local tax burden was 12.1 percent of income. If the types of non-tax receipts the Tax Foundation improperly included are removed from the Commerce Department data, the average state and local tax burden drops one-sixth, to 10.1 percent.(15) (See Table 2.)
Undercounting Family Income
In addition to the two types of methodological problems described above the overestimation of the taxes a median-income family pays and the counting as taxes of receipts that are not taxes the Tax Foundation also undercounts the income of its median families. There is a fundamental 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 methodology attempts to count comprehensively all types of taxes levied at all levels of government. It applies that broad definition of taxes to a hypothetical median-income family that is assumed to receive 96 percent or 97 percent of its income from wages. The problem here is that the Tax Foundation does not credit the family with the non-wage income it would have to receive to owe various taxes the Tax Foundation assumes the family pays. This makes the tax burdens of the Foundation's median families seem higher than they are.
The Tax Foundation's treatment of the federal corporate income tax illustrates this problem. Economists generally agree that individuals ultimately pay corporate income taxes and that in calculating a tax burden, it is necessary to distribute appropriately to individuals both the corporate taxes and the profits on which those taxes are based. The standard convention for doing this is to include the appropriate amount of corporate taxes for the family both as a tax payment the family makes and as a component of the income it receives. The Congressional Budget Office's analysis of tax burdens follows this approach.(16) The Tax Foundation violates this standard. It mismatches taxes and income by including federal corporate income taxes as part of the taxes that median families pay without including a corresponding measure of corporate income as part of the income these families receive.
State and Local Taxes in 1997 as a
Percentage of the Net National Product
(in billions of dollars)
Net National Product
23.5 0.3% Corporate Profits Tax Accruals 37.4 0.5% Indirect Business Taxes
38.2 0.5% Total State and Local Taxes 725.0 Net National Product 7148.9 Taxes as Percent of NNP 10.1% Source: U.S. Department of Commerce, Bureau of Economic Analysis, February 1998.
Data for corporate profits tax accruals and the Net National Product are an average for the first three quarters of 1997. Since the Net National Product will be higher in the fourth quarter, taxes as a percentage of NNP in 1997 should be slightly lower than shown here.
Other personal taxes include estate and gift taxes, motor vehicle license taxes, personal property taxes, and other license taxes. Other indirect business taxes include motor vehicle taxes, severance taxes and license and stamp taxes.
In addition to these taxes, the Tax Foundation appears also to have counted as state and local taxes contributions for social insurance ($86.2 billion, or 1.2 percent of NNP) and portions of "other" indirect business taxes that are non-tax receipts (amounting to $23.8 billion, or 0.3 percent of NNP). It is unclear whether the Tax Foundation counted personal non-tax receipts, which totaled $31.0 billion, or 0.4 percent of NNP; this report assumes it did not do so. The Tax Foundation's methodology could not be fully determined from the brief description the Tax Foundation report contained.
Tax Foundation Results Differ from Mainstream Research
Measuring the tax burden of a median-income family is a complex endeavor. It entails determining how each type of income and each type of tax are distributed across income groups. If either income or tax payments are mis-measured or are not distributed correctly, the estimate of the tax burden will be too high or too low.
Not all of the data needed to make a precise estimate of the overall tax burden of a median-income family are available; there is insufficient information available on state and local tax burdens. Nevertheless, organizations such as the Congressional Budget Office and the Joint Committee on Taxation use standard practices to measure the percentage of income paid in federal taxes, and there are standards that can be employed to use the information available on state and local taxes to make measurements of state and local tax burdens that are more accurate than the Tax Foundation's estimates.
The Congressional Budget Office periodically issues a well-respected analysis of federal tax burdens. CBO looks at all types of cash income. It also distributes to families indirect income such as corporate profits.(17) Using its relatively broad measure of income, CBO calculates the types and amounts of federal taxes that families pay. The CBO analysis includes the effects of federal individual income taxes; social insurance taxes such as Social Security, Medicare, and Unemployment Insurance taxes; corporate income taxes; and excise taxes. (CBO does not distribute estate taxes or customs duties, which make up less than three percent of federal taxes and have little effect on the taxes of a typical middle-income family.)
In mid-1997, prior to passage of the 1997 tax law, CBO estimated that the federal tax burden on the middle 20 percent of families would equal 19.7 percent of income in 1998.(18) By contrast, the Tax Foundation states that median families pay 26.1 percent of income in federal taxes. Because the Tax Foundation overstates taxes and understates income, it shows an effective federal tax rate nearly one-third higher than the tax burden in the CBO analysis.
The Joint Committee on Taxation also analyzes and issues data on tax burdens. Prior to passage of the 1997 tax law, JCT estimated that the middle 20 percent of families would pay 15.9 percent of income in federal taxes in 1998. The JCT estimate is lower than the CBO estimate for two reasons. JCT includes employer-provided fringe benefits in its measure of income, while CBO does not. In addition, JCT does not include the effects of corporate taxes on families. Although the omission of corporate taxes would have a major impact on the tax burden of high-income families, its impact on measuring of the tax burden of median-income families is relatively minor, because capital assets are highly concentrated at higher income levels. As compared to the Joint Committee on Taxation's estimates, the Tax Foundation overstates the federal tax burden by more than half.
No source comparable to CBO or JCT exists for state and local tax burdens, and it is a complex endeavor to measure the percentage of income consumed by taxes that 30,000 separate state and local entities levy.(19) It is understandable that the Tax Foundation would use the state and local tax data included in the Commerce Department's National Income and Product Accounts to derive a state and local tax figure. But in using the Commerce data, the Tax Foundation did not acknowledge the intrinsic shortcomings of these data for estimating tax burdens, such as that these data include capital gains taxes but not capital gains income. In addition, the Tax Foundation compounded the problems associated with using the Commerce data by counting as taxes various state and local receipts that are not taxes, such as contributions to employee pensions funds, business fines, and rental revenues.
Although data are not available to derive a precise combined federal, state, and local tax burden figure for a median-income family, the tax burden can be approximated by combining the federal tax burden on a median-income family, from either the Congressional Budget Office or Joint Committee on Taxation analyses, with the average state and local tax rate from the Commerce Department data, as adjusted to remove receipts that clearly are not taxes.
Using the CBO analyses of federal tax burdens, the combined federal, state, and local tax rate for a median-income family before considering the effects of the 1997 tax reductions would be approximately 29.8 percent of income. (This equals a 19.7 percent federal tax burden, plus the 10.1 percent state and local burden derived from the Commerce data when the non-tax items are removed.) Relative to this measure, the Tax Foundation figure of a tax burden equaling 38.2 percent of income overstates the combined tax burden by 28 percent.
Using the Joint Committee on Taxation's analysis of federal tax burdens, the median-income family pays approximately 26 percent of income in federal, state, and local taxes before considering the effects of the 1997 tax reductions. (This equals a 15.9 percent federal tax burden plus the 10.1 percent state and local burden.) Relative to this measure, the Tax Foundation's 38.2 percent figure overstates the combined tax burden by 47 percent.(20)
These figures do not include the effects of the tax reductions enacted in 1997, some of which were effective for the 1997 tax year. If these reductions were taken into account, the combined tax burden would be seen to be somewhat lower than noted above, and the discrepancy with the Tax Foundation figures would be still greater.
While taxes as a percentage of income fluctuate from year to year, the trend over the past two decades has been remarkably stable. 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 and were estimated to equal 19.7 percent income in 1998 prior to passage of last year's tax-cut legislation. (See Figure 1.) It is likely that as a result of the new law, the federal taxes a median-income family pays in 1998 will constitute as low or lower a percentage of income than in 1977 and most years since then.
A recent Treasury Department analysis gives some indication of current federal 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.(21)
The long-term trend for state and local taxes as well 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 fell below 9.3 percent of income or rise above 10.3 percent of income.
1. Tax Foundation, Family Tax Burdens 20 Year Later, Revisited, February 5, 1998.
2. In mathematical terms, the Tax Foundation's calculations regarding state capital gains taxes fail to match the taxes paid, the numerator in the fraction that represents the percentage of income the median family pays in taxes, to the measure of income used as the denominator in the fraction.
3. In the course of preparing this report, the author pointed out this error to Tax Foundation staff. The Tax Foundation issued a correction on February 13, 1998. In issuing the correction, the Tax Foundation also "updated" the data in ways that offset the extent to which the correction lowered the tax burden. The Tax Foundation revision made no corrections for any of the other types of methodological flaws detailed in this report. The Tax Foundation's "corrected" tax burden on the dual-income family changed little from the level shown in its November 1997 report, from 38.2 percent to 37.6 percent.
4. The Wall Street Journal, January 27, 1998.
5. USA Today, January 6, 1998.
6. The Net National Product data come from the Commerce Department's National Income and Product Accounts. The Net National Product is the Gross National Product minus the depreciation of fixed capital assets.
7. In 1997, the first $600,000 of an estate was exempt from taxation. In some circumstances the exemption was greater. This general exemption is scheduled to rise in future years, reaching $1 million by 2006.
8. Research by New York University Professor Edward Wolff. Wealth is defined as assets less debt. Data on gross asset holdings are not available but likely would show a similar pattern.
9. The Tax Foundation's brief methodology section specifies that 96 percent of its dual-earner family's income comes from wages. The comparable figure for its one-earner family is 97 percent.
10. The Tax Foundation does not specify the sources of the remaining three percent to four percent of income, but the Census data on which the Tax Foundation bases the income figures that it uses for its median-income families show that the remaining three percent to four percent of income comes from sources such as Social Security, unemployment insurance, and veterans' benefits, plus a small amount of interest and dividend income.
11. In the brief methodology discussion in its report, the Tax Foundation stated it had not used the normal assumption about the incidence of the federal corporate income tax, which is that owners of capital ultimately pay the tax, but made an alternative assumption instead. The Tax Foundation assumed that the corporate tax burden is divided in three equal ways: on consumers through higher prices, on workers in the form of lower wages, and on corporate shareholders in the form of lowered profits. Even following its own assumptions, the Tax Foundation is internally inconsistent here. If the Tax Foundation wants to assume the tax falls on workers in the form of lower wages, it must follow the same procedure as it did for the employer's share of the Social Security tax that is, it must add the tax to income as if the wages had not been reduced, as well as adding it to taxes paid. Similarly, if the Tax Foundation wants to show that the tax lowers corporate profits, it must include the family's share of corporate profits in the family's income, as well as including the corporate tax as a share of the family's taxes. As a result of these methodological flaws, the Tax Foundation incorrectly applies an average corporate income tax rate to a narrow measure of family income that does not include the very type of income on which this tax is levied.
12. Some of the Tax Foundation's other tax studies also make the mistake of counting capital gains taxes but not capital gains income when computing federal tax burdens. The November 1997 Tax Foundation report does not commit this error, because it uses an overall effective federal personal income tax rate derived from the IRS statistics of income, not from this Commerce Department data series.
13. 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 derives from these accounts, as does the Net National Product.
14. The author was unsuccessful in obtaining information from the Tax Foundation regarding the exact portions of state and local government receipts that were counted. Instead, the Tax Foundation methodology was inferred from a comparison of the tax burden figures shown in its report with the Commerce Department data.
15. Most of the difference between the 12.1 percent and 10.1 percent figures is due to the removal of non-tax revenue items. Other reasons for the difference are that the 10.1 percent figure is derived from more
recent data and that, as explained in footnote 3, the Tax Foundation made an error in computing state and local tax burdens under its own methodology.
16. The Joint Committee on Taxation does not include any measure of corporate income; it also does not distribute corporate taxes to individual families. Both the CBO and JCT thus have assumptions regarding income and taxes that are internally consistent.
17. CBO also adjusts for family size when arraying families in income classes. This takes into account the fact that a single person with income of $20,000 would have a much higher standard of living than a family of four with the same income.
18. Congressional Budget Office, "Summary Federal Tax Information by Income Group and Family Type Projected for 1998 Based on CBO's January 1997 Forecast," May 15, 1997.
19. Citizens for Tax Justice has published a study on the distributional analysis of state and local tax systems. It applies only to non-elderly married couples, who may have a different distribution of tax burden than other families. In addition, it considers only those taxes that are borne by a state's own residents. So, for example, the portion of Florida's or Hawaii's sales taxes that are "exported," that is, paid by visiting tourists, are not counted anywhere in the study. This is an appropriate procedure for considering a specific state's taxes, but results in a modest understatement of the national state and local tax burden when the results for all states are summed. The CTJ study showed the state and local tax burden on a family in the middle 20 percent of the income distribution to be 9.8 percent in 1995. Citizens for Tax Justice and The Institute on Taxation & Economic Policy, Who Pays? A Distributional Analysis of the Tax Systems in All 50 States, June 1996. It should be noted that states have cut taxes substantially since 1995.
20. As noted earlier, the Tax Foundation issued a correction to its tax burden figure for dual-earner families in February 1998. If the corrected figure of 37.6 percent of income is used instead of 38.2 percent, the overstatement is 26 percent relative to the estimates based on CBO data and 45 percent relative to the measure based on Joint Committee on Taxation data.
21. 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.