Tax Winners and Losers
As is the case every April, the deadline for paying one’s federal income taxes brought forth many news features on the burden of taxation. This year was no different, with one article by former White House press secretary Ari Fleischer in The Wall Street Journal getting particular attention.
Fleischer’s main point is that a growing percentage of the population is paying no federal income taxes. He said the figure is 40 percent, based on a recent study by the Congressional Budget Office showing that the bottom two income quintiles (20 percent of households) paid no federal income taxes in the aggregate in 2004. This is because the Earned Income Tax Credit offsets all of the tax liability for those who had incomes below $29,400.
Fleischer was quickly taken to task by liberals like Jared Bernstein of the Economic Policy Institute and Jonathan Chait of The New Republic for ignoring the burden of payroll taxes on those with low incomes. The same CBO data cited by Fleischer show that those in the bottom quintile paid 8.2 percent of their income in payroll taxes and the second quintile paid 9.1 percent.
This is the standard liberal response to data showing that the wealthy are shouldering a greater and greater share of the income tax burden. According to the CBO, those in the top quintile paid 85.3 percent of all such taxes in 2004. In 1979, the first year of the CBO study, this group paid only 64.9 percent.
Inclusion of payroll taxes in the calculation doesn’t change the picture that much because the top quintile of households paid 44.2 percent of all payroll taxes in 2004. Overall, this group paid 67.1 percent of all federal taxes — well above their share of reported income, which was 53.5 percent.
Of course, we have a progressive tax system, and the wealthy are expected to pay more than their proportional share of taxes. The CBO data confirm that our federal tax system is indeed very progressive. Looking at all federal taxes, including payroll taxes, those in the lowest quintile paid 4.5 percent of their income to the federal government in 2004, the second quintile paid 10 percent, the third paid 13.9 percent, the fourth paid 17.2 percent, and the top quintile paid 25.1 percent.
The tax cuts enacted by Ronald Reagan and George W. Bush have lowered the top tax rate quite a bit — it has fallen from 70 percent in 1979 to 35 percent today. Moreover, Reagan also raised the payroll tax rate by 3 percentage points. Knowing only this, one would assume that the wealthy are paying much less than they were in 1979 and the poor are paying much more. In fact, every income class has seen a decline in its effective federal tax rate (taxes as a share of income), including payroll taxes.
According to the CBO, the lowest quintile paid 8 percent of its income in total federal taxes in 1979, the second quintile paid 14.3 percent, the third quintile paid 18.6 percent, the fourth quintile paid 21.2 percent, and the top quintile paid 27.5 percent. Thus, the lower 80 percent of households saw a much greater reduction in their total federal tax rate despite the rise in the payroll tax because federal income taxes dropped much more.
These figures, however, really tell us nothing about how much each income class ought to be paying. One of the points Fleischer was making is that all Americans should pay something to finance the general costs of government. After all, the poor as well as the rich benefit from things like national defense.
A new study by the Tax Foundation attempts to calculate the benefits of government spending by income quintile in the same way taxes are calculated. It shows that government spending is also steeply progressive, with those with low incomes receiving far more than those at the top.
According to the study, those in the bottom quintile received 33.8 percent of all federal spending in 2004, the second quintile received 21.8 percent, the third quintile received 16 percent, the fourth quintile received 13.4 percent, and the top quintile received just 15 percent.
The reason for this is that many of the federal government’s largest programs are geared specifically to aid those with low incomes. In the case of Social Security, the benefit formula gives those in the bottom quintile twice as much in benefits at retirement as they paid in taxes during their working lives, according to another CBO study. Those in the top quintile only get back half the taxes they paid. Consequently, the overall Social Security program, looking at both taxes and benefits, is steeply progressive — a point that is almost always ignored by those who complain about the burden of the payroll tax on the poor.