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News from EPI New tool examines how U.S. taxes and spending affect income inequality

Today, the Economic Policy Institute is launching a website aimed at shedding light on how the U.S. tax and spending system affects household income up and down the income distribution.

The U.S. Tax & Spending Explorer allows users to take a deep dive into the ways that the federal government affects the inequality of households’ incomes through taxes and through spending on social insurance and safety net programs. The explorer also examines so-called “tax expenditures,” sometimes referred to as the hidden federal budget.

“A nation’s taxes and spending reflect its priorities,” said EPI Research Director Josh Bivens. “Many would argue that offsetting the rise of inequality in recent decades should be a fiscal priority. But meeting that goal requires knowing which parts of the federal tax and spending system affect inequality—and how—today. Our new Tax & Spending Explorer visually explains how people at every income level experience taxes and spending—both overall and for specific taxes and spending programs.”

Taken as a whole, the federal tax system is progressive—people with higher incomes tend to face higher tax rates. For instance, the bottom 20% of households pay just 0.9% of their income in federal taxes, while the top 1% of households pay one-third of their income in federal taxes. Two of the most progressive taxes, the individual income tax and the corporate tax, account for a majority of federal tax revenue. But decades of corporate tax cuts and increases in payroll taxes, which are less progressive, have weakened the equalizing effect of the federal tax system. This decline in corporate tax rates also explains why some analyses of the absolute richest households (the top 0.1% or the Forbes 400, for example) show their tax rates are actually lower than those faced by typical taxpayers.

While the federal tax system tends to reduce inequality, state and local taxes tend to increase it. The bottom 20% of households pay 11.4% of their incomes in state and local taxes, while the top 1% pay just 7.4%. About a third of taxes that Americans pay are actually going to state and local governments.

The website explains that the federal government spends about $4 trillion a year, an amount equal to about 20% of the total national income of the United States. Nearly two-thirds of that money goes directly back to households as “transfers”—safety net and social insurance programs that transfer resources to individuals and families with specific needs. At a point in time, these transfers are quite progressive. For example, the bottom 20% of households receive 53.4% of their income through transfers, while the top 1% receive just 0.6% of their income from transfer spending.

Safety net programs such as Supplemental Nutrition Assistance Program (SNAP) and Medicaid are extraordinarily progressive, by design: Through transferring a large share of federal resources to the households most in need, they help equalize incomes across the distribution. Social insurance programs are not purely income-based but are still progressive in practice—in part because Social Security and Medicare provide benefits to older households, who tend to have far lower market-based incomes than their working-age peers.

Tax expenditures include the exemptions, deductions, and credits that lead to income being taxed differently depending on its sources and taxpayers’ circumstances. Together, they reduce taxes collected by the federal by about $1.5 trillion, an amount equal to 7% of U.S. national income. In theory, these tax expenditures have been put in the tax code by Congress to encourage individuals and corporations to work toward socially desirable goals—such as saving for retirement or investing in plants or equipment—or to benefit specific groups, such as working parents. In practice, except for refundable tax credits like the Earned Income Tax Credit (EITC) and Child Tax Credit (CTC), tax expenditures primarily benefit the top 20% of households.

Finally, the explorer highlights some trends in projected spending and taxes. Federal spending is projected to increase by roughly 4% over the next 30 years, mostly due to an increase in health care spending. Over the long term, the major driver of increased spending is the rising cost per person of providing health care. Health care costs are growing disproportionately to the rest of the economy. Reining in health care costs would narrow the gap between federal spending and revenues and substantially increase disposable income that could be spent on non-health goods and services. The international comparisons page on the Tax and Spending Explorer, moreover, highlights that even if the projected increases in spending come to pass, the United States will still be a relatively low-spending and low-taxing country relative to many of our rich-country peers.

“There seems to be no binding economic constraint on increasing taxes and spending,” said Bivens. “The fiscal future really boils down to political choices, including the political choice of how much we value a more equal society.”

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