Tuesday, January 13, 2009

Is American tax system progressive - Mankiw Vs Kenworthy?

Greg Mankiw interprets the latest CBO data on effective federal tax rates (total federal taxes divided by total income) to claim that American tax system is progressive. In contrast, on deeper scrutiny, Lane Kenworthy uses data on all taxes, from CBO and Tax Foundation, to show that the US tax system is far from progressive.

Lane Kenworthy finds that if we include all taxes - federal, state, and local - the effective tax rate for the well-to-do is only a bit higher than for the poor. In another blog post, Kenworthy also shows that effective tax rates and thereby whether taxes are progressive depends on how income is defined. If income is measured as market income — income from employment, investments, and a few other sources, but not including government transfers — the tax system is essentially flat. As Kenworthy writes, "It (US tax system) does very little to alter the market distribution of income. Redistribution is achieved mainly by government transfers rather than by taxes." Kenworthy's arguements appear to have settled the matter!

However, such debates draws attention to the fact that the more relevant issue is in judging the progressivity of different types of taxes and not the entire taxation systems. As Justin Wolfers points out by drawing attention to the famous case of Warren Buffet (the richest American pays just 17.7% of his total income as tax, compared to 30% for his secretary!), these figures conceal important anomalies within the American taxation system. Many critical direct taxes are structured to benefit the rich, especially those at the very top - capital gains tax is a mere 15% compared to income tax rate of 35% and payroll taxes are capped for income of $100,000 and therefore decreases (as proportion) with income.

Update 1
Economix explores the inequality debate in the US from the taxation perspective, in light of President Obama's new tax proposals. Economix also explains the marginal tax rate here. OECD nations' tax tables available here.

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