"Knowledge will forever govern ignorance"

--James Madison--

"The real division is not between conservatives and revolutionaries, but between authoritarians and libertarians"

--George Orwell--

Money and Taxes--Who Makes It, Who Pays Them?

People are in my office frequently, complaining about the government and having to pay for it.  They ask me what I think of something that they heard.  People hear stuff all of the time.  Sometimes it was some talk show or their brother in law's plumber or maybe even FOX News.  What do I think about the “fact” that 47% of households don't pay any tax?

Well, I looked into it:

The 47% Myth

Things are always more complicated than that.  But even people who pay no income tax are still paying other taxes.  There are lots of taxes.  It adds up to well over 50% of your income, right?  Maybe not:

The 50% Myth

I am told by some that the top 10% of income earners pay 3 / 4 of all taxes.

I am told by others that this same top 10% makes as much as 80% of the income in the US.

Both are somewhat off.  But neither is terribly far from the truth, either.

Tax cuts can eventually lead to lots of people not paying tax.  At least not income tax.  The payroll tax is flat (regressive), so it's harder to escape, unless you start making six figures.  Then you don't have to pay the Social Security portion.

I will be referring frequently to data from two publications.  The first is the Congressional Budget Office's compilation of tax and income statistics from 1979-2007.  It has to be a huge undertaking, because they are gleaning the data from the IRS, the Census, and various other Treasury and Interior agencies.  Which helps to explain why they're only finished through 2007.

CBO Income and Tax Data, 1979-2007

This chart is from the CBO report

The IRS also publishes an "abstract" of Federal tax returns, which includes data on both income and income tax paid.  This one is complete through 2008.

This chart is from the 2008 IRS abstract

The top 10% of Americans by income earn about 42% of the country's reported income, which is up from 31% in 1979, but still quite a bit less than 80%.

They pay about 73% of total income tax revenues, which is where the infamous 3/4 figure probably comes from.

But there are more taxes than just the income tax.  There is also the payroll tax, for Medicare and Social Security.  These people don't pay SS tax on earnings above $108K/yr, so that dilutes their share of the payroll tax, which they pay a little more than 25% of.

Putting it all together, including investor's shares of the corporate income tax, each individuals share of income, payroll, and federal excise taxes, and this same 10% that makes 42% of the country's income pays about 55% of all Federal tax revenues.

In 1979, when they had 31% of the income, their share of the income tax was 48%, and their share of total Federal Tax liabilities was about 41%.

So, in the pre-Reagan era, while income was distributed more evenly than it is today, the wealthy actually paid a lesser share of both the income tax and Federal taxes overall.


The two biggest reasons are the Tax Reform Act of 1986, and EGTRRA 2001.  The first eviscerated tax shelters for the wealthy, and the second showered everybody below median income with not only rate cuts, but also enough  refundable tax credits that most people in the bottom 50% pay little to no Federal income tax.

Both rich and poor had their taxes slashed dramatically.  The middle class above median income?  Not quite so much.

So what about most of us?  The lower 60%.

This group has an average income of about $45K/yr.  They make about 26% of the country's income.  Yes.  The lower 60% make just over a quarter of the US total personal income.

They pay just over 1% of Federal income tax revenues.  That's no mistake, folks.  1.3%, to be more precise.

Their share of Federal payroll taxes is 32%, and they pay a total of 14% of all Federal tax revenues.

In effect, what has happened over the past 30 years or so is that wealth and income have become more concentrated, but so has tax liability.  On the other hand, rates are lower, so even though their share has increased, it's a bigger share of a smaller pie.

In 1979, the average effective income tax rate (overall tax, as opposed to marginal tax bracket) for the top 1% was 21%, and it was 7.5% for people in the middle quintile.  In 2007, those had dropped to 19% and 3.3%, respectively.

But before calling for anything as simple as a return to pre-Reagan tax rates, remember that that would also double the income tax for much of the middle class.  Rather, we should be calling for an end to tax favored treatment of some investment income, and an increase in top marginal rates to over 50% again.

What we don't need to do is go to consumption taxes, which are very regressive.  But that's exactly what Ron Paul and other prominent libertarians are proposing with their "Fair Tax".  Fair to who?  That's always the question, now, isn't it?  One that I'll be exploring soon.  But not today.