Are Taxes (And Also Spending) Progressive?
The Brookings Institution and EconoFact
The recent claim that in 2018, the 400 wealthiest American families paid, on average, a smaller percentage of their income in taxes (23 percent) than the percentage paid by the bottom half of all U.S. households (24 percent) has generated enormous attention and controversy. This assertion is featured in The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay, a new book by University of California, Berkeley economists Emmanuel Saez and Gabriel Zucman. The finding that the tax burden is disproportionately higher for lower income families is at odds with common perceptions that the United States has a progressive tax system. And it has particular relevance because the country has seen a marked increase in income inequality over the past several decades.
A finding that the 400 wealthiest households pay a smaller share of their income in taxes than do the bottom half of U.S. households is cause for debate.
- The progressivity of a tax system reflects how the proportion of income paid in taxes varies for taxpayers as their income rises. A progressive tax system is one in which people with higher income pay a higher share of their income in taxes. For example, the income tax is generally progressive – people do not pay taxes on their first several thousand dollars of income, and there are rising tax rates with higher levels of income. In contrast, in a regressive system a household’s share of income that goes to taxes falls as income rises. Social Security’s payroll tax is regressive since it is not charged on any earnings above $132,900, so those earning above this threshold pay an increasingly lower percentage of their income to this payroll tax as their income rises (see here for instance). It is important to note however, that looking only at Social Security's payroll tax gives you an incomplete view of the progressivity of the system. When you take Social Security benefits into account, the overall Social Security program – including benefits – is progressive.
- The calculation of the progressivity of a tax system is not straightforward. One seemingly simple way to assess the progressivity of the tax system is to look at how average tax rates (the ratio of taxes to income) varies as household income rises. This apparent simplicity is deceptive, however, because a variety of assumptions must be made – What counts as a tax? How should taxes be assigned to households – for example, which households bear the burden of the corporate tax? What counts as income? How should income be adjusted for family size? Assigning taxes can be complicated and involves different assumptions. For example, while corporations are legally responsible for remitting corporate tax payments to the government, the economic burden of the tax is ultimately borne either by the owners or shareholders (in terms of lower earnings, lower stock valuations or lower dividend payments) or by workers in the form of lower wages or by some other person. How much of the corporate tax incidence is borne by these groups is a matter of debate and is particularly relevant for determining the progressivity of the U.S. tax system in the wake of the 2017 Tax Cuts and Jobs Act which reduced corporate taxes from 35 to 21 percent (see here).
- In their book, Saez and Zucman reach conclusions that are at odds with a variety of previous studies. They conclude that the U.S. tax system (including federal, state, and local levies) is essentially proportional for about 99.99 percent of the population and that the top 400 households pay a slightly smaller share of income in taxes than the rest of the population (see the website companion to their book). In contrast, previous studies have found the combined federal and state tax system to be progressive, with the extent of the progressivity varying at different points along the income distribution (these include earlier work by Saez and Zucman together with Thomas Piketty, a study by Gerald Auten and David Splinter and a study from the Institute on Taxation and Economic Policy). What explains the difference? Relative to previous estimates, the current choices and assumptions made by Saez and Zucman generate higher estimates of income among high-income households, and of taxes on low-income households (see the analysis by Joint Committee on Taxation economist David Splinter).
- Considering only positive tax payments gives an incomplete picture of the tax system. Some taxes are “refundable” and actually offer credits, such as the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC). These credits can create negative tax liability for households. For example, if a household pays $1000 in a given year but receives $1,500 in an earned income tax credit, on balance, they have paid negative taxes. Conventional analyses count programs such as the EITC and the CTC as negative taxes, but Saez and Zucman exclude these credits from their analysis, making the tax system look more regressive than other studies show.
- Focusing on the tax system alone gives an incomplete picture of how government policies can bear on income inequality. A tax system in which the wealthy pay a lower share of their income in taxes than the poor helps fuel increasing income inequality. A more comprehensive view would take into account not just tax payments, but also the redistribution of income that takes place through refundable tax credits, government transfer payments, and public investments or subsidies in the provision of education, health, and other services. Studies show that the combined tax and transfer system is quite progressive (see here).
- A greater degree of tax progressivity is not synonymous with greater redistribution in society. For example, a tax system where Bill Gates pays $1 and everyone else pays zero is extremely progressive (the rich pay 100 percent of the tax!) but would provide little redistribution. In practice, most redistribution (just over 60% in the U.S. and 75% in the OECD) occurs through spending policies not tax policies. Relative to other countries, the U.S. has a fairly progressive tax system but less than average redistribution. This is because the U.S. generates far less revenue, 26% of GDP, than the other OECD countries who collect an average of 33% of GDP. Taken together, U.S. taxes and transfers do less to redistribute income than 26 out of 30 OECD countries.
What this Means:
If each additional dollar means more for a low-income family than a billionaire, some might prefer a system that distributes the tax burden with higher tax rates on the well-to-do than on the middle class and the poor. But it is not a simple task to calculate the progressivity of the tax system. Nor is it obvious that only taxes should be considered. It is clear, however, that the overall tax and transfer system in the United States is progressive. Nonetheless, the United States government redistributes fewer resources to low-income households than other advanced countries.