Blog Post

AEIdeas



This is an updated and revised version of a CD post from last year that generated nearly 300 comments because of the controversial nature of the topic – whether “the rich” pay their “fair share” of taxes or not – so I expect another lively discussion this year!

The Congressional Budget Office (CBO) recently released its annual report titled “The Distribution of Household Income and Federal Taxes, 2013. ” In that publication, the CBO provides detailed data on American households for each income quintile in 2013 for: a) average household “market income” (includes labor income, business income, income from capital gains, and retirement/pension income), b) average household transfer payments (payments and benefits from federal, state and local governments including Social Security, Medicare, Medicaid, unemployment insurance, and Supplemental Nutrition Assistance Program (SNAP)), and c) average federal taxes paid by households (including income, payroll, corporate, and excise taxes). Some of the key findings of the CBO analysis are displayed in the table above, with the data organized by household income quintiles. The data in the first four rows above appear in the CBO report (from Tables 1 and 3), and rows 5-8 above have been calculated separately based on data from the first four rows in the table.

Scott Greenberg and John Olsen of The Tax Foundation recently summarized some of the key findings of the CBO report in their post “Are the Rich Paying Their Fair Share Yet?“, here are their main conclusions:

One of the main takeaways from this year’s report is that the richest Americans pay a lot in taxes. In 2013, the top 1% of households paid an average of 34% of their income in federal taxes. To compare, the middle 20% of households paid only 12.8% of their income in taxes. Moreover, taxes on the rich are much higher than they’ve been in recent years. Between 2008 and 2012, the top 1% of households paid an average tax rate of 28.8%. However, in 2013, this figure spiked to 34%, as a result of tax increases in the “fiscal cliff” deal and the Affordable Care Act. We’ve known for a while that taxes rose on the rich in 2013, but the new CBO report puts in perspective exactly how high taxes on rich are now, compared to the last three decades. For instance, in 2013, the top 1% of taxpayers paid a higher tax rate (34%) than in the year Reagan took office (33.2%). According to the CBO, the federal tax system is now “the most progressive it has been since at least the mid-1990s.”

Some additional analysis and commentary will be provided here to support the conclusions of The Tax Foundation on tax progressivity and reveal a major implication of the CBO report – almost the entire burden of: a) all transfer payments made to American households and b) all non-financed government spending, falls on just one group of Americans – the top one-fifth of US households by income. That’s correct, the CBO study shows that the bottom three income quintiles representing 60% of US households are “net recipient households” (they receive more in transfer payments than they pay in federal taxes), the second-highest income quintile pays just slightly more in federal taxes ($17,600) than it receives in government transfer payments ($15,000), while the top 20% of America’s “net payer households” finance almost 100% of the transfer payments to the bottom 60%, as well as almost 100% of the tax revenue collected to run the federal government. Here are the details of that analysis.

The figures in Row 6 in the table above (and displayed in the graph above) show the amount of federal taxes paid by the average household in each income quintile minus the average amount of government transfers received by those households in 2013. For each of the three lower-income quintiles, their average government transfer payments exceeded their federal taxes paid by $8,800, $12,200, and $7,800 respectively, and therefore the entire bottom 60% of US households are “net recipient households” of government transfer payments. Averaged across all three lower-income quintiles, we could say that the lowest 60% of American households by income received average transfer payments of nearly $10,000 in 2013 ($9,600 to be exact). And because the government has no money of its own, where did those transfer payments come from to finance the “net recipient households”? Where else, but from the top two income quintiles, and realistically almost exclusively from Americans in the highest income quintile.

Specifically, the average household in the fourth income quintile paid slightly more in federal taxes ($17,600) than it received in transfer payments ($15,000) in 2013, making the average household in the second-highest income quintile a “net payer household” in the amount of $2,600. Basically, households in the fourth income quintile paid enough in taxes to cover their transfer payments, and then made a minor contribution of $2,600 on average per household to help cover the transfer payments of the “net recipient households” in the bottom 60% and make a small contribution to the federal government’s other expenditures.

But the major finding of the CBO report is that the households in the top income quintile are the real “net payer households” supporting the federal government. The average household in the top one-fifth of American households by income paid $69,700 in federal taxes in 2013, received an average of $12,000 in government transfers, and therefore made a net positive contribution of $57,700 per household on average. The second-highest income quintile households are minor “net payer households” (contributing 4% on per average household to the average net positive payments of the top two income quintiles, i.e. $2,600 / $2,600 + $57,700), but it’s really the top 20% of “net payer households” that are financing 96% of the transfer payments ($57,700 / $60,300) to the entire bottom 60% AND financing most of the non-borrowed operations of the entire federal government.

Here’s another way to think about the burden of the “net payer households” in the top income quintile. The average US household in that group made a contribution net of transfers in 2013 in the amount of $57,700. That would be equivalent to the average household in the top quintile writing four checks: 1) one check in the amount of $8,800 that would cover the net transfer payments received by the average household in the bottom quintile, 2) another check for $12,200 to cover the net transfer payments received by the average household in the second lowest quintile, 3) a third check in the amount of $7,800 to cover the average net transfer payments to a household in the middle-income quintile, and 4) then finally writing a check for the balance of $28,900 that would go directly to the federal government, which for the households in the quintile as a whole would have covered 96% of the non-financed federal government spending in 2013. So except for a small positive contribution net of transfers in the amount of $2,600 from the average household in the fourth quintile (about 4% of the total net positive payments), the highest income quintile is financing 96% of the entire system of transfer payments to the bottom 60% AND funding the operation of the federal government.

And yet don’t we hear all the time that “the rich” aren’t paying their “fair share” of taxes and that they need to shoulder a greater share of the federal tax burden? Hey, they (the top 20%) are already shouldering 96% of the entire federal tax burden along with financing almost the entire system of entitlements and transfer payments! And that’s not “fair” enough already?

The chart above shows another way that the CBO data reveal an extremely unequal distribution of government transfer payments and federal taxes by displaying the ratio of “dollars received in government transfers per dollar paid in federal tax revenues” by income quintile in 2013 (these data are from row 8 in the table above). The average household in the lowest quintile received $9,600 in government transfer payments in 2013 and paid only $800 in federal taxes, for a ratio of $12.00 in transfer payments for every $1.00 paid in federal taxes that year. In contrast, the average household in the top income quintile received $12,000 in government transfers in 2013, but paid $69,700 in federal taxes, for a ratio of 17 cents in government transfer payments per dollar paid in federal taxes. This analysis is a further illustration that the bottom three quintiles are “net recipient households” that received more than $1 in government transfer payments for every $1 paid in federal taxes in 2013, while households in the fourth quintile were minor “net payer households” in 2013 and received slightly less than a dollar in transfer payments on average ($0.85) for every $1 paid in federal taxes. In contrast, “net payer households” in the top income quintile received only $0.17 in government transfer payments per $1 paid in federal taxes in 2013.

The final chart above shows average federal tax rates by income quintile in 2013, both before and after government transfer payments. The dark blue bars in the chart show the average tax rates for American households by income quintile, calculated from the top table above by dividing Federal Taxes Paid (row 4) into Before-Tax Income (row 3, Market Income + Government Transfers). Adjusting for government transfers received, the light blue bars in the chart are calculated by dividing “Federal taxes paid minus government transfers received” (row 6 in the table) into Before-Tax Income (row 3), and show average federal tax rates by income quintile after government transfers. For example, the average “net recipient household” in the lowest income quintile received a “negative tax” payment of $8,800 in 2013, had an average before-tax income of $25,400, for a negative federal tax rate of 35%. Reflecting their “net recipient household” status, all three lower-income quintiles had negative average tax rates in 2013, and only the “net payer households” in the top two income quintiles had positive after-transfer federal tax rates of 2.5% for the second-highest quintile and 21.8% for the top quintile. This further demonstrates that after transfer payments, Americans in the bottom 60% by income are “net recipient households” with negative federal income tax rates, while only households in the top two “net payer” income quintiles had positive federal income tax rates after transfers in 2013.

Bottom Line: We hear all the time from President Obama, Bernie Sanders, Hillary Clinton, Warren Buffett, Robert Reich, and various other Democrats and liberal pundits that “the rich” aren’t paying their fair share and need to be taxed more. For example, in 2013 (the tax year the new CBO report covers) Obama reiterated his belief that the wealthiest Americans still aren’t paying their “fair share” of taxes. He said “Obviously, there is still more to do when it comes to reducing our debt. And I’m willing to do more, as long as we do it in a balanced way that doesn’t put all the burden on seniors or students or middle class families, but also asks the wealthiest Americans to contribute and pay their fair share.”

The CBO study released this month provides ample evidence that the richest Americans are paying their “fair share” of federal taxes. In fact, the richest 20% of Americans by income aren’t just paying a share of federal taxes that would be considered “fair” – it goes way beyond “fair” – they’re shouldering almost 100% of the entire federal tax burden of transfer payments and all other non-financed government spending. What’s probably not so fair is that the bottom 60% isn’t just getting off with a small tax burden or no tax burden – the bottom 60% are net recipients of transfer payments from the top 20% to the tune of about $10,000 per household in 2013. So maybe what the CBO report shows is that we should be asking whether or not the bottom 60% are paying their fair share when they’re not paying anything – they’re net recipients of transfer payments that come mostly from “the richest” 20% of American households.

It’s also important to note here that the US has the most progressive federal tax system among all OECD-24 countries, see Tax Foundation president Scott Hodge’s article “No Country Leans on Upper-Income Households as Much as the US.” Specifically, the top 10% of American households pay 45.1% of all income taxes (both personal income and payroll taxes combined), which is the highest tax share for that group in any of the OECD-24 countries and far above the 31.6% average for the tax burden of the top income decile. Accounting for the income share of the top income decile, the US also has the highest ratio of the income tax share of the top 10% (45.1%) to the total income share of that group (33.5%) of 1.35 times, compared to the OECD average ratio of only 1.11.

When the top 20% of US households are financing 96% of the transfer payments to the bottom 60% and financing almost the entire non-financed operating budget of the federal government, I’d say “the rich” are paying beyond their fair share of the total tax burden, and we might want to start asking if the bottom 60% of “net recipient” households are really paying their “fair share.” At the very least, we should be thanking the top 20% of Americans for shouldering such a disproportionate share of the federal tax burden, and not constantly vilifying them and proposing to increase their taxes in the interest of “fairness.”

HT: As I mentioned last year, I owe the inspiration for this post to Morgan Frank, who provided the original idea, discussed the development of the analysis, and also suggested several of the charts above.