Revised, April 15, 1999

Taxes on Middle-Income Families Are Declining
by Iris J. Lav

Click here for the revised version of this report.

Table of Contents

I.  Middle-Income Tax Burdens are Declining

II.  Are Tax Burdens Rising Overall?

III.  Recent Tax Cuts Have Driven Down Tax Burden

Analysis of "Tax Freedom Day"

Taxes on middle-income families have fallen over the past few years. The percentage of income that these families pay in taxes is now lower than in most other years of the past two decades.

Table 1
Percentage of Income That
Median-Income Families Pay in Tax
Federal 1995 1999
Congressional Budget Office 19.7% 18.9%
Joint Committee on Taxation 17.3% 16.1%
State and Local    
Average Taxes (1995 and 1998) 10.2% 10.2%
Using CBO for federal tax 29.9% 29.1%
Using JCT for federal tax 27.5% 26.3%
Source: Congressional Budget Office, May 1998; Joint Committee on Taxation, November 14, 1995 and September 15, 1998; U.S. Department of Commerce, Bureau of Economic Analysis, August 1998 and February 1999.1

To be sure, the total amount of taxes collected by the federal government, measured as a percentage of the Gross Domestic Product, has risen in recent years. This increase has been driven by increased collections from high-income taxpayers, not by increased taxes on middle-income taxpayers. Both CBO and conservative economist Lawrence Lindsey, among others, have found that the increased collections are due largely to a large jump in capital gains income and to bonuses paid to highly-compensated executives.


Middle-Income Tax Burdens are Declining

Analyses by both the Congressional Budget Office and the Joint Committee on Taxation show the combined federal tax burden of a middle income family has declined.

Chart 1
Figure 1

Families pay state and local taxes as well. Unfortunately, there are no data that would allow determination of the level or trend in total state and local taxes borne by middle-income families. But data on total state and local taxes as a percentage of the economy suggest these taxes have been stable in recent years.

Tax Foundation’s Average Tax Measure is Not the Same as Tax Burden

Each April 15, the Tax Foundation issues a report about what it calls "Tax Freedom Day." This year’s report contends Americans will work until May 11 to pay their taxes. In making this claim, the Tax Foundation relies on a measure of average taxes; the Foundation takes what it says is the total amount paid in federal, state, and local taxes and simply divides this amount by its estimate of the total amount of income in the nation. It calls this figure the taxes that Americans pay on average. For a number of reasons, the Tax Foundation calculation is a deeply flawed measure of the percentage of income that most Americans pay in taxes. Moreover, the Tax Foundation’s presentation of these figures invites middle-income taxpayers to believe that they pay considerably more of their income in taxes than the data show to be the case.

Average tax figure misleading. The average tax burden is itself a misleading figure. Middle-class families do not pay the average tax burden; they pay less than that. This is a result of the progressive structure of the federal income tax, under which the wealthy pay a substantially higher percentage of income in federal taxes than the middle class or the poor do. While the typical middle-income family is in the 15 percent federal income tax bracket, high-income families are in brackets with marginal rates more than twice that high and pay much higher percentages of income in federal income tax than middle-class families do.

The problem of using averages is easily seen. Suppose four families with $25,000 incomes each pay $1,250 in income tax — or five percent of their income — while one wealthy family with $500,000 in income pays $125,000 in income tax, or 25 percent of its income. On average, these five families pay 22 percent of their income in federal income taxes (total tax payments of $130,000 divided by total income of $600,000 equals 22 percent). But the 22 percent figure is misleading if used to portray middle-class tax burdens. The four moderate-income families pay five percent of their income in income tax, not 22 percent.

Using averages when talking about tax burdens produces skewed results. It ascribes to middle-class families average amounts of such taxes as the estate tax and the corporate income tax. These taxes, however, are paid solely or primarily by taxpayers at considerably higher income levels than the average middle-class taxpayer.

Non-tax items counted. The Tax Foundation counts as taxes items that are not taxes. These include: optional Medicare premiums that older Americans pay if they wish to receive coverage for physician’s services under Medicare; intra-governmental transfers that are solely bookkeeping devices and not taxes; employee and employer contributions to state and local government pension plans, some of which results in the double-counting of taxes; and rental payments that individuals or businesses pay to state or local governments to rent property those governments own.

Taxes counted, but taxed income not counted. The Tax Foundation counts capital gains taxes as part of the taxes people pay, but it fails to count as part of people’s income the capital gains income on which these taxes are levied. 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. In addition, in a period such as the present when capital gains income and hence taxes on such income are rising rapidly, the Tax Foundation procedure makes even average tax burdens appear to grow faster than they actually are growing.

These flaws in measurement of taxes and income have led the Tax Foundation to show that taxes are rising, when data from authoritative sources show tax burdens on typical middle-income families are falling.

As described below, average federal tax rates have been rising, largely as a result of tax collections attributable to booming stock-market profits. This phenomenon has little effect on middle-income taxpayers because income on these profits is concentrated among people at higher income levels. In addition, the large number of state tax cuts enacted in recent years suggests that state and local taxes on middle-income families may be declining, even though average state and local tax rates are stable. More than three-fifths of the states have enacted significant tax cuts in recent years.


Are Tax Burdens Rising Overall?

Total federal tax collections measured as a percentage of the economy — taxes as a percentage of GDP — have risen in recent years. So have overall average tax burdens as shown in Census data. These increases are due in large part to the extraordinary increase in capital gains income and other income that high-income taxpayers have received over the past few years as the stock market has soared; the increases in capital gains tax collections and taxes on bonuses that highly-compensated executives receive have little effect on the tax burdens of most Americans.

Moreover, measuring tax burdens as a percentage of GDP can be misleading. Taxes paid on capital gains income are counted as part of total tax collections, but capital gains income is not counted as part of GDP. Thus, when measuring taxes as a percentage of GDP, capital gains taxes are counted but the income on which these taxes are paid is not.

This means that when capital gains income and capital gains tax collections both rise sharply, as has occurred in recent years, tax burdens measured as a percentage of GDP rise more rapidly than tax burdens are actually increasing. With capital gains income now playing a major role in the increase of federal revenues, this distortion has taken on added importance.

Increases in taxes as a percentage of GDP have little bearing on whether taxes on median income families are rising; the recent evidence shows that increases in taxes on high-income taxpayers are pulling up average taxes at the same time that taxes on median-income families are declining. Moreover, measures such as taxes as a percentage of GDP no longer even accurately portray changes in average taxes because of the distortion introduced by failing to count capital gains income. As a result of these two problems, those who cite increases in taxes as a percentage of GDP — or in average tax burdens — as evidence that tax burdens on typical middle-class families are increasing commit a double error. They disseminate misleading information.


Recent Tax Cuts Have Driven Down Tax Burden

The percentage of taxes that typical middle-class families pay in total taxes has been declining in large part because federal income tax burdens on families — and particularly on families with children — are sharply lower than they were 10 or 20 years ago. The new federal $500 per child credit and education credits and deductions have lowered taxes on middle-income families with children.

But recent tax reductions have not been limited to middle-income families or to families with children. Higher income taxpayers are benefitting from a cut in the maximum tax rate on capital gains income from 28 percent to 20 percent. While capital gains income is soaring, most dollars earned in the stock market are being taxed at lower rates.

A variety of other federal tax reductions enacted in 1997 will show up as lower tax burdens in future years; a number of the provisions in that legislation phase in over a period of years. The Joint Tax Committee projected at the time the legislation was enacted that tax reductions under the Taxpayer Relief Act of 1997 will grow from $9.9 billion in fiscal year 1999 to $35 billion in 2003 and $41.6 billion in 2007.

Substantial reductions in state taxes also have been enacted in recent years. Since 1994, more than three-fifths of the states have enacted significant net tax reductions; one-quarter of the states have enacted net tax increases. Some 28 states, about two-thirds of those with state income taxes, have enacted significant personal income tax cuts in the past five years.

The data in this report show average state and local taxes for 1998. Most of the tax reductions enacted during 1998 state legislative sessions, when 21 states enacted significant reductions in taxes, are not fully reflected in the 1998 data.(7) This suggests average state and local taxes could be lower in 1999 than in 1998. Moreover, 18 states have enacted tax cuts that are phasing in and will take effect in years after 1999, further reducing taxes in future years.

End Notes:

1. 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. Taxes are for families in the middle quintile of the income distribution, with average income of $39,000 in 1999. 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. Taxes are for families with income between $30,000 and $40,000. State and local taxes are from the National Income and Product Accounts and include personal taxes, corporate profits tax accruals, and indirect business taxes. The rate shown is an average tax rate — taxes as a percent of Net National Product — for the first three quarters of 1998.

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.

2. Distributional Effects of the "Taxpayer Relief Act of 1998" (JCX-63-98), September 15, 1998 and Distributional Effects of the Revenue Reconciliation Provisions of H.R. 2491 As Agreed to by the Conferees (#D-95-79), November 14, 1995.

3. U.S. Department of Commerce, Bureau of Economic Analysis, National Accounts Data, various years.

4. Perspectives on the Ownership of Capital Assets and the Realization of Capital Gains, Congressional Budget Office, May 1997; Auerbach, Burman, and Siegel, Capital Gains Taxation and Tax Avoidance: New Evidence from Panel Data, University of Michigan Business School, Working Paper Series No. 98-13.

5. June E. O'Neill, The Economic and Budget Outlook: Fiscal Years 1999-2008, Testimony before the Senate Budget Committee, January 28, 1998.

6. Lawrence B. Lindsey, Federal Tax Policy, testimony before the Senate Budget Committee, January 20, 1999.

7. National Conference of State Legislatures, State Tax Actions, various years.