Wednesday, April 15, 2009

American tax system debate - progressive or not?

Economix presents two graphics that clearly indicates that, contrary to interpretations of the latest CBO estimates (full paper here), the US taxation system is far from being progressive.



Horizontal axis shows the income group. Vertical axis shows the percentage of income that the average member of that group pays in taxes. Taxes include all federal, state and local taxes (personal and corporate income, payroll, property, sales, excise, estate, etc.). Incomes include cash income, employer-paid FICA taxes and corporate profits net of taxable dividends (but not government transfers).



Horizontal axis shows the income group. Taxes include all federal, state and local taxes (personal and corporate income, payroll, property, sales, excise, estate, etc.). Incomes include cash income, employer-paid FICA taxes and corporate profits net of taxable dividends.

It is pertinent to remind ourselves that a taxation system is loosely considered progressive if the "rich pay more taxes than the poor". The last phrase has been interpreted, both statistically and gramatically, by different sides to validate their claims. However, given the vast and ever widening disparities in income, conventional interpretations of the phrase which center on the shares of the income paid as taxes and/or the taxes paid, may be misleading.

As Lane Kenworthy (summary here and here) has argued very convincingly, it is important that all judgements of the taxation system be made only after including all the different types of taxes - federal, state and local - and all the sources of income, both market income and government transfers. All these taken together, and as the graphics above clearly indicates, the US taxation system is relatively flat and not progressive.

The Economix has been running a series of posts on this issue here, here and here.

Update 1
Robert Reich dispels some of the common American tax myths here.

Update 2
Freakonomics feels that the numerous deductions and tax breaks not available in other countries ensures that the effective corporate income taxes in the US — the tax rates companies actually pay — are among the lowest in the developed world.

Update 3
Economix (see also here on the relative sources of incomes for the rich and richest Americans) points that the richest Americans pay a lower share of their incomes in taxes than the nearly richest Americans, mainly due to the lower rate on capital gains (which is the increasingly major source of income for the richest Americans) tax.



IRS figures show that once a taxpayer earns about $2 million in annual income, the effective tax rate starts to fall. Americans earning more than $10 million a year, for example, pay an effective income tax rate of 19.7 percent on average, whereas those making $500,000 to $1 million a year pay an effective tax rate of 23.4 percent.

Update 4 (29/6/2010)
See these excellent graphics on the impact of various taxes on the different percentiles.

Update 5 (24/4/2011)

Paul Krugman points to the fact that the share of the total taxes paid by all income groups were similar to their incomes themselves, thereby raising doubts about the progressivity of US taxation.



Update 6 (22/9/2011)

Paul Krugman uses data from CBO for 1979-2005 to estimate the impact of change in taxes on the after tax incomes of people at different income percentiles. Changes in tax rates have strongly favored the very, very rich.

2 comments:

Peter said...

I am confused by the second graph "Shares of Income and Taxes Paid". It seems, unless it is an illusion due to the grouping, that the graph shows a significantly different distribution of effective tax rate than the other two. In the first and Third graph, there the highest tax rate is near the top but not the top. In the middle graph, there is a valley in what I believe should be the same income level. What am I missing?

gulzar said...

good point peter. assuming that the graphs are all correct, the only explanation would be that the total incomes of the top 1% are so high, compared to that of the remaining 4% and 5%, that their share of taxes and income are also much higher.

this squares up nicely with the income distribution in the post below

http://gulzar05.blogspot.com/2011/01/new-tax-slab-for-uber-rich.html