Rev. May 10, 1999
Tax Foundation Figures Produce Misleading and Inaccurate
Impressions of Middle Class Tax Burdens
by Iris J. Lav, Isaac Shapiro, and Robert Greenstein
Additional tax-related reports
On April 15, the Tax Foundation issued a report stating that on average, Americans must work until May 11 to pay taxes. Each year since 1993, the Tax Foundation has claimed that the average American's tax burden has reached a new record high, and that "Tax Freedom Day" occurs later in the year.
The Tax Foundation's claim of ever-increasing tax burdens is in direct contradiction to evidence from the two leading sources of tax information for Congress the Congressional Budget Office and the Joint Committee on Taxation. These authoritative sources find that taxes on typical middle-income families are substantially lower than the taxes the Tax Foundation claims Americans pay on average. Moreover, CBO and the Joint Committee on Taxation find that taxes on middle-income families have been declining in recent years, not rising as the Tax Foundation reports would lead the public to believe.
Joint Committee on Taxation data are changes in federal taxes for families with income between $30,000 and $40,000. The Congressional Budget Office data are for families in the middle quintile of the income distribution, with average income of $39,000 in 1999. The JCT and CBO data on federal taxes are combined with Commerce Department data on state and local taxes to estimate total taxes. State and local taxes from the National Income and Product Accounts are taxes as a percent of Net National Product. Tax Foundation data are from "Tax Freedom Day" reports, which use average taxes for all taxpayers.
Why is there this contradiction between the Tax Foundation and these two much more authoritative sources of tax data? It is because the picture the Tax Foundation presents that the tax burden is high and has been rising is inaccurate when applied to typical or average middle-class families. The Tax Foundation computes what it describes as the percentage of income that Americans, on average, pay in taxes and converts this to the portion of the year that Americans have to work to pay their tax bills. This methodology draws a misleading picture; it substantially exaggerates the amount of taxes that average middle class families pay. (See box below for a discussion of the Tax Foundation's use of averages and terms such as "on average" and "Americans.")
Under the methods the Tax Foundation uses, an increase in taxes solely on high-income taxpayers increases the taxes that the average taxpayer pays and thereby advances "Tax Freedom Day" to later in the year. 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 important ways as well. Of particular concern, the Tax Foundation fails to count some of the income on which the taxes that it counts are levied. It counts capital gains tax payments as taxes but fails to count as income the capital gains income on which these taxes are levied. In addition, the Tax Foundation counts as taxes various items that clearly are not taxes, such as the optional premiums that elderly and disabled people elect to pay for physicians coverage under Medicare. The methodological errors that the Tax Foundation commits all distort its figures in the same direction they all make taxes look higher than they actually are.
In assessing the Foundation's report, the following points merit consideration.
1. The federal tax burden the Tax Foundation says families pay on average is about 28 percent larger than the federal tax burden that CBO estimates the typical family bears and about 51 percent larger than the federal tax burden the Joint Tax Committee estimates the typical family bears. In its Tax Freedom Day report, the Tax Foundation estimated that families on average pay 24.3 percent of their 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 18.9 percent of income in federal taxes in 1999, while the Joint Committee on Taxation's estimate is 16.1 percent. The Tax Foundation's estimates are more than one-fourth to one-half higher than the estimates of these more authoritative institutions.
The federal tax burden posited by the Tax Foundation is not only higher than what CBO and Joint Tax Committee estimate middle-income families pay, but is also higher than what CBO estimates families in the next-to-the-top fifth of the population pay. CBO estimates that families in the next-to-the-top fifth will pay 22.2 of income in federal taxes in 1999. The Tax Foundation claims that Americans on average pay more than 24 percent.
Both the Center on Budget and Policy Priorities and a number of prominent economists such as William G. Gale of the Brookings Institution have for some years criticized the Tax Foundation's methods as providing a misleading picture of the taxes that middle-class families pay. As noted elsewhere in this report, the average tax burden figure the Tax Foundation derives and on which Tax Freedom Day is based is substantially higher than the tax burden that families in the middle of the income scale pay. This is in part because the Tax Foundation's method ascribes to middle-income families types of taxes and tax rates that apply primarily or solely to upper-income taxpayers.
The Tax Foundation has responded to this criticism by tweaking the wording of its reports. In 1996, it described Tax Freedom Day as "...the day the average American can expect to quit working for Uncle Sam...." By 1998, the Tax Foundation was saying, "On this day, Americans on average will have earned enough...." and using phrases such as "...the tax burden borne by Americans..." [Emphasis added.]
Despite this slight change in wording, the tone of the Tax Foundation's reports clearly invite the reader to believe he or she works until May 11 to pay taxes. The Tax Foundation material does nothing to help the reader understand that "Americans on average" would, under our progressive tax system, pay a substantially higher tax bill than a typical, middle-income family. Indeed, Congressional Budget Office data show that the percentage of income paid in federal taxes by "Americans on average," as the Tax Foundation computes it, exceeds the percentage of income paid in taxes not only by families in the middle of the income spectrum but even by families in the next-to-the-highest fifth of the income spectrum.
2. Taxes have been declining for 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' incomes in 1979, 19.4 percent of income in 1989, and 18.9 percent of income in 1999. This is a trend toward modestly lower federal taxes on middle-income families, not higher taxes as the Tax Foundation claims. The Tax Foundation itself admitted this point in a February 1998 release that received little coverage, where it acknowledged 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)
Nor have taxes been rising at the state and local level. Commerce Department data show that state and local taxes amounted to 10.2 percent of Net National Product in 1998. This Commerce Department measure of state and local taxes has been remarkably stable over time; it was at almost the same level in 1998 and throughout the 1990s as in 1977.(2)
3. 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 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 testified on this matter in 1998. O'Neill 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."(3)
Lawrence Lindsey, an economist who served in the Reagan and Bush administrations and on the Board of Governors on the Federal Reserve System, sounded a similar note in testimony before Congress in January 1999. Lindsey said, "A disproportionate share of this extra revenue is coming from upper income taxpayers through higher income tax payments. The likely reason for these payments is the booming stock market. The extra revenue is in part due to higher capital gains realizations due to higher stock prices, but is probably even more dependent upon higher bonuses being paid to upper bracket individuals."(4)
Neither of these developments has much or any effect on families in the middle of the income scale. Yet 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 though those taxes were paid by the average taxpayer, making it appear as though middle-class families have to work longer to pay their taxes than they actually do.
4. The Tax Foundation's use of averages substantially exaggerates middle-class tax bills. In contending Americans must, on average, work until May to pay taxes, the Foundation computes average tax burdens. It 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 Americans as paying, on average, in taxes. The Foundation then converts this into the percentage of the year Americans must work to satisfy their tax obligations. There are fundamental problems with this approach.
The federal personal income tax 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 tax burden figure that the Tax Foundation computes by dividing total taxes by total income is misleading as an indication of the taxes that average or middle-class Americans pay. When applied to federal taxes, this tax figure significantly exceeds the percentage of income that both families in the middle of the income spectrum and families in the next-to-top fifth pay.
The problem of using the Tax Foundation's approach 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. Under the Tax Foundation approach, these five families pay 22 percent, on average, 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. The four moderate-income families pay five percent of their income in income tax, not 22 percent. Using averages in the manner the Tax Foundation does when talking about tax burdens produces skewed results; it essentially 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 method 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 averaging method effectively assumes that typical middle-class families pay the same percentage of income in corporate income and capital gains tax as wealthy investors and stockholders. That clearly is not correct.
Tax Levels versus Expenditures on Food, Shelter and Housing
Tax Foundation reports often 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 figures on total tax payments in the nation, 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.
5. The Tax Foundation's methodology contains other shortcomings that make taxes look larger as a percentage of income than they are. The 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. The Foundation's inclusion of items that are not taxes overstates state and local tax burdens by about one-seventh.
Furthermore, the Tax Foundation methodology fails to count all income. The methodology 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 is the case.
6. The Tax Foundation numbers frequently are used by those who argue either that the federal income tax code should be replaced with a flat tax or consumption tax or that deep income tax cuts should be the nation's top budget priority. The argument is that federal 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. 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 that families in the middle of the income spectrum will pay 5.4 percent of income in federal individual income tax this year. In the Tax Foundation's terms, that means it will take only until January 20 for the typical household to pay its federal income taxes. Congressional Budget Office analyses show that three of every four families are paying less than 10 percent of their incomes in federal individual income taxes.
In addition, Treasury Department analyses show that 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.
1. Tax Foundation, Family Tax Burdens 20 Years Later, Revisited, February 5, 1998.
2. This measure represents an average state and local tax rate for taxpayers of all income levels. Data are not available on the state and local tax burdens of typical middle-income families.
3. June E. O'Neill, The Economic and Budget Outlook: Fiscal Years 1999-2008, Testimony before the Senate Budget Committee, January 28, 1998.
4. Lawrence B. Lindsey, Federal Tax Policy, testimony before the Senate Budget Committee, January 20, 1999.