The Shifting Burden of Federal Taxes

Part I: Yesterday we drilled down through the Congressional Budget Office's data on household wealth across the income distribution, as presented in their November 2014 report, The Distribution on Household Income and Federal Taxes, 2011.

Part II: Today we look at the federal tax data from the same report. Again, when analyzing the data we are avoiding political chest thumping or partisan baiting around ideas of "income inequality", "paying their fair share" and so on.

Part III: There is actually a significant body of academic research dedicated to analyzing income disparities over time - though it is necessarily evaluates a somewhat short historical window, since the data on household wealth only goes back to the early 1960s, and data on income taxes in the US and some industrialized countries only goes back to the early 1910s. As it turns out, the growth in "income inequality" that the US has seen since the late 1970s has taken us back to a similar range seen in the 1920s. This phenomena has been mimicked to greater or lesser extent in other industrialized countries of western Europe. Next week we will recap some of the academic research with various theories on why the income disparity shrank from the post-depression era to the early 1970s, then rose dramatically again back to pre-WWII levels over the past 30 years.

Recap: Household Wealth and the Impact of the Top 1%

The reason so many policy analysts, political pundits and reality shows seem obsessed with those whose income or net wealth puts them in the "top 1%" is because, well, they really are accumulating vast amounts of wealth at a pace far above the (rest of us slobs) other 99%. The first chart below shows household income gains made by: 

• the middle quintile (40-60% of households on the income distribution), 
• fourth quintile (60-80%) and 
• the highest quintile (top 20%, or 80-100%) 

in the U.S. since 1979. The highest quintile is further broken down in the first graph to the 81st to 90th percentile, 91st to 95th percentile and 96th to 99th percentile to show finer detail of which strata of that top 20% of the income distribution has made the most gains. 

What is left out of the graph above is the growth in household income of the "top 1%". We repeat a graph from yesterday which shows the dominance - not of the "top 20%" - but actually of the sliver of the "top 1%". 

In the table below we summarize changes in the average before-tax household income across the distribution from 1979 to 2011. Comparatively, it is the increase in household income of the top 1% that is dramatically outpacing that of all other groups. However, it is the middle quintile - the U.S. middle class itself - whose average increase in household has been the lowest over the past 33 years, at just 24%. Compare this to the top 1% of households, who have seen a rise of 175% in their average before-tax household income over the same period. 

But there is some nuance here that's important to factor in, and that the political flame-throwers find it convenient to ignore. 

The Rise of the Two-Income Household

From Wikipedia and the US Census Bureau (edited for brevity, formatting added):

Household income changes over the course of time, with income gains being substantially larger for the upper percentiles than for the lower percentiles. All areas of the income strata have seen their incomes rise since the late 1960s, especially during the late 1990s.

The overall increase in household income is largely the result of an increase in the percentage of households with more than one income earner. While households with just one income earner, most commonly the male, were the norm in the middle of the 20th century, 42% of all households and the vast majority of married couple households now have two or more income earners. With so many present day households having two income earners, a substantial increase in household income is easy to explain.

Two income earner households are far more common among the top quintile of households than the general population. 2006 U.S. Census Bureau data indicates that over three quarters, 76%, of households in the top quintile, with annual incomes exceeding $91,200, had two or more income earners compared to just 42% among the general population and a small minority in the bottom three quintiles. As a result much of the rising income inequity between the upper and lower percentiles can be explained through the increasing percentage of households with two or more incomes

There is also evidence that we will review next week that the rich have increasingly married each other. That is, the trend of doctors, lawyers and finance executives to inter-marry, making the dual-income households that much wealthier, is a significant factor in the growth in income of the top 20% and indeed the top 1%. This seems not to be true for business owners - who actually by far make up the lions share of the top 1%. 

Tax Burdens: Increasing on the Top 20%, Almost Non-Existent on the Bottom 40%

The CBO compiles federal income taxes paid by households across four categories: 

• Individual income taxes - federal taxes paid net of earned income tax credits, benefits and refunds, which are essentially social programs conducted via tax policy instead of fiscal policy. 
• Payroll taxes - Taxes for Social Security and Medicare, paid by employees and employers. These were reduced by 2.0% from 7.65% to 5.65% of wages up to ~$107k in 2011 and 2012, then rest to their previous levels in 2013.
• Corporate income taxes - "Corporate taxes aren't paid by companies, but passed along to consumers." The CBO apportions some of these taxes to households. Don't ask me how. 
• Excise taxes - federal taxes on a good or service, such as gasoline, cigarettes and alcohol. 

The biggest portion of total federal taxes paid by most income groups is average (often called effective) individual income taxes, so we start there.

The chart above shows a history of the average (effective) individual income tax rates by income quintile from 1979 through 2011. Two trends worth noting: 

1. The average effective federal income tax rate for the bottom to quintiles has dropped from 0 to 4.0% in 1970 to -7.5% and -1.3% in 2011. That means ~40% of households are on a net basis receiving refunds and credits through the federal government that are larger than their income taxes paid from wages. This is what politicians and policy analysts are often referring to when they say "income redistribution". 
2. The highest quintile has had its effective federal income tax rate shrink modestly over the same period from 15.9% to 14.2%. The CBO notes in its report that tax law changes as of 2013 raised the effective income tax rate for the highest quintile by up to 4.3% - to an estimated 18.5% - though it does not yet appear in the data. 

Skipping to the total average federal income tax rates by group, we have the following graph:

So the total tax burden on each income quintile has decreased since 1979, but the drop for the bottom 80% has been significant while the drop for the top 20% has been smaller. 

Again - before anyone starts gnashing their teeth about the rich getting soaked - how has that impacted overall after-tax incomes, given the (enormous) rise in incomes for the top quintile compared to everyone else?

Well, well well. What do you know. On an after tax income basis everyone is doing better, but the rise in income for the top 1% is the highest: up 175% on a before-tax basis (shown in previous table) but up 200% on an after tax basis over the past 33 years. 

However, there is nothing magical about 1979 other than thats when the the CBO's household income data series starts, and we need to consider trends in taxes and income over a longer period and put it into a broader context. 

So until next week, don't leap to any conclusions.