Commentary | Budget Taxes and Public Investment

A Tale of Two Taxpayers

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Every tax season, conservatives claim that the federal tax system is unfair because the top 1% of taxpayers pay a disproportionately large share of federal income taxes–in 2006 they paid 39.1% of all income tax revenues. But this complaint is misleading on many counts.

First, it ignores all other federal taxes, most egregiously the payroll tax, which is a higher tax burden than the income tax for 83.3% of households and for which the top 1% pay a rate nearly six times lower than the average taxpayer. The top 1% actually pays 28.3% of all federal tax revenues.

More importantly, the conservatives’ complaint also ignores the fact that this group receives a disproportionate share of income (currently at 18.8%), and that this share has nearly doubled since 1991. Since the top 1% enjoy an increasing disproportionate share of total income, it makes sense that they would also pay a high share of taxes.

But there’s even more to the story. Income growth, which can help offset tax bills, has been tremendously unequal over the last 15 years. To illustrate, let’s look at two taxpayers and how their experience over the last 15 years informs our understanding of relative tax burdens. A recently released analysis by the Congressional Budget Office, which runs through 2006, is a good starting point.

In 1991 the average taxpayer in the top 1% made $721,100. In the subsequent 15 years, this group’s real income rose by an average 6.1% per year, reaching $1,743,700 in 2006. In fact, between 1991 and 2006 the cumulative income growth for this top group (over and above their 1991 income level) was actually 113% higher than their total tax bill over this period. This left them with an extra $800,000–after taxes–at the end of the 15-year period. Far from being a huge burden, the tax bill for high-income taxpayers appears to be easily manageable in light of their tremendous income growth.

The average taxpayer in the middle 20% wasn’t so lucky. In 1991 he or she made $59,600–about 7.3% of what the taxpayer in the top 1% made–and experienced a mere 1% real average growth per year. Over the next 15 years the total tax bill for the average taxpayer in this group was over twice as much as the cumulative income growth, meaning that unlike the taxpayer in the top 1%, this middle-income taxpayer could not pay his tax bill exclusively with his cumulative income gains over this period.

What explains this discrepancy? Among other things, taxpayers in the top 1% have shifted much of their income away from wages and into capital gains, which is taxed at a much lower marginal rate. In 1991 wages comprised 37.6% of income for the top 1%, while capital gains were only 12.7%–by 2006, wages fell to 26.2% of total income and capital gains rose to 29.3%. This has resulted in the top 1% facing a low effective federal tax rate–the lowest, in fact, since 1992.

Left out of this discussion is the concept of relative pain; that is, how much each taxpayer can pay. The data show that the top 1% are doing exceptionally well–their income started off high in the early 1990s and grew at a fast enough pace to more than compensate for their tax bills. By comparison, the average taxpayer in the middle 20% has experienced stagnating wages and is likely struggling with skyrocketing health care, education, and transportation costs. For the top 1%, this may be the best of times, but for everyone else it ain’t so great.

See more work by Ethan Pollack