The Difference Between Average and Marginal Taxes

U.S. average tax rates are at historical lows. Yes, that’s right. Our taxes aren’t “high”, despite the Tea Party’s claim that we are “taxed enough already”. The average family pays approximately 5% of gross income as U.S federal income tax.

How can that be you ask? Well, the political rhetoric that quotes tax rates of 33% or 39% or 50% or the historical high of 91% are all marginal tax rates. They tell us what percent of income above a certain threshold (typically in the $250,000 range) gets paid as tax. For all taxpayers, even high income earners, the first money earned is taxed at the lower rates. Indeed, the way personal exemptions work, the first thousands of dollars of income aren’t taxed at all. In contrast the average tax rate is figured by taking the total dollars of taxes paid and dividing it by total income. The average tax rate is the best measure of how burdensome or not-burdensome taxes really are.

In the U.S., for the median income family, the average tax rate is near 5% as shown in the graph. This is down dramatically from 12% in the late 1970’s. It’s even down significantly from the 6% we paid in 2006! At a 5% average rate, this means that 95% of your gross income is available for other purposes. For many households, the rate is even lower if your income is below the median.

But what about the rich and the high income bracket folks? Aren’t they being “taxed to death” with those supposedly awful, allegedly job-killing 35% marginal rates? No. Those are marginal rates. A married filing jointly household will only pay that 35% on income after the first $379,150. (source: Tax Foundation). Further, much of high income gets sheltered. If the income came from capital gains, it’s taxed at a lower rate. Income paid to pay interest on mortgage doesn’t get taxed and neither do a host of other deductions. So how much do these high-income people pay? Not as much as you think or they want you to believe. Let’s look at another chart, also from CBPP.

So the millionaires, the folks with incomes over $1 million only pay an average rate of approx. 22%. What’s really startling about this chart is how mere millionaires ought to be upset. The really, really, ultra-rich, the top 400 households in America pay only 16-17% average tax rate.

So we’ve got the median household income, which is around $50,000 per year pays 5%. A millionaire pays 22%. And a real high multi-millionaire pays only 17%. This is hardly highway-robbery style redistribution of income.

A Better Comparison – Let’s Add Payroll Taxes.

But if we are going to compare tax burdens by income brackets, we really need to look at more than just federal income tax. We definitely need to add in payroll taxes – social security and medicare taxes. These payroll taxes were payable on all income up to $106,800 in 2010. The rate for Social Security tax and Medicare combined was 7.62% (not counting the employer’s share) (source: Payroll Experts.com). Now it gets tricky. The median household with an estimated $50,000 income paid 7.62% payroll tax on their entire income. So the combined federal income and payroll tax bite on the median family income was approx. 12.6%.

Now let’s figure the millionaire. Let’s suppose that someone with a million dollar income paid 22% in federal income tax. Actually it would likely be less since the 22% figure is from all incomes over million, many of them much over. But for the sake of argument, we’ll say they paid 22%. But they would have only paid the 7.62% payroll tax on the first $106,000 and none on the rest. This means that the millionaire’s average payroll tax was 0.76%. So the combined federal income and payroll average tax rate for the millionaire is no more than 22.76%. The gap between the median and the millionaire is much smaller than widely believed.

For the Top 400 households, the payroll tax is insignificant, so their combined tax rate is around 16-17%.

Overall, the U.S. is not high tax burden country. But, the tax burden is not fairly or progressively shared anymore. The burden falls heaviest on those least able to pay.