The Share of Income Taxes by Rich and Poor

We last reported on this in October, but since then the IRS has released the 2007 data, the latest available.

It’s tax day. Celebrate! It’s still more than likely that you (of our Stateside readers) are one of the few left supporting the government, feeding the beast whose stated goal is to eat you. A sort of inverse delicious irony.

Anyway, various news reports are stating that about 47% of all Americans will pay no federal income tax. This is true, but the statistic is slightly misleading because most in the half that don’t pay income tax do pay social security tax, health (a.k.a. medicare) tax, gas taxes, and various other revenue-raising fees thought up by our leaders.

Even that is misleading, because a good chunk of the half that don’t pay income, but do pay those other federal taxes, receive a socialistic redistribution of wealth through the mechanism of the “earned” income credit. Which goes to show you that marketing is everything: for this “earned” income is, of course, unearned. It is money taken from those that have earned it and given to those who have done nothing to earn it. Except live.

The true federal tax burden (ignore states and municipalities) is difficult to calculate for any individual because gas taxes and other federal fees are not reported to the IRS; they obviously vary significantly from individual to individual.

However, we can crudely guess that about 10% of all Americans end up with zero—or even negative—federal tax liability. The “negative” comes from the welfare they receive via the EIC, the excess of medicare and social security benefits they have received, and so on.

This share of folk must be increasing, as the following picture suggests:

Share of taxes paid by bottom 50% of Americans

This is the percent share of federal income taxes paid by the bottom 50% of income earners, as defined by the IRS. The light red and blue shading indicate the Republican or Democrat presidencies, respectively. These colors are deemphasized because, as is obvious, the downward trend is independent of administrations (as it is of Congresses).

We can look at more than just the bottom 50%: here’s the same thing but for the bottom 99%, 95%, 90%, 75%, and 50%.

Share of taxes paid by bottom 99%-50% of Americans

Income redistribution is progressing nicely, thank you very much. Show these pictures to your socialist pal next time he complains that the rich have too much money. Also show him this next picture, which is the burden on the top 1% of income earners.

Share of taxes paid by top 1% of Americans

It’s hard to guess the precise number, but it appears that the top 1%, generous souls that they are, will have paid just under 45% of all taxes in 2010. And, of course, with Mr Obama’s stated policy of tax increases for the rich, this will rapidly approach 50%.

There is a possible objection to this analysis. The top 1% of earners could have increased their income at a rate higher than those in the bottom 99%. Both groups could have increased, but if the top 1% increased faster, it could account for their increased tax layouts.

Here is a picture that helps answer that—but only “helps” because that IRS data is (purposely?) flawed.

Ratio of Adjusted Gross Incomes of Top 1% and Bottom 50%

This is the ratio of adjusted gross incomes of the top 1% to the bottom 50%. In 1987, for example, the total adjusted incomes of the bottom 50% equaled the total adjusted incomes of the top 1%. This ratio held roughly until 1996 when it increased in the top 1%’s favor. As of 2007, these folks made an adjusted income about 1.9 times the adjusted incomes of the bottom 50%. The dip from the last recession and the Bush tax cuts is obvious.

The huge problem lies in the word adjusted. The IRS mysteriously does not report actual incomes, but only adjusted gross incomes, which are the amounts made after subtracting various (standard and variable) deductions from the actual income.

We can’t tease out from these numbers how much greater are the real incomes of the top 1%, but it does appear they have grown somewhat proportionately higher. The picture is exaggerated in the top 1%’s favor, because deductions are a much higher and growing proportion of the incomes of the bottom 50%.

Dear Socialist Pal, those bottom 50% have grown richer, too! This picture shows the total adjusted gross incomes for both the top and (artificially deflated) bottom groups.

Total Adjusted Gross Incomes for Top 1% and Bottom 50%

It’s clear that what happened was that the “poor” grew richer steadily, but the “rich” in the Great Internet and Stock Boom of the late 1990s, grew faster. Those richies were, of course, the folks with the capital. The post-2001 retrogression in the economy is more obvious for the top, as is their accelerating income in the Great Subprime Mortgage Boom of the late 2000s. The current recession is not in this data.

Another common mistake is to think that the top 1% in 1986 were the same people in 2007. They were not, obviously. A great many of those rich folk in 1986 are dead and now earn nothing. Others will have retired, and many new faces will have appeared.

Oh, my: so many reasons to be unhappy. And we haven’t even touched on the VAT! Another time; another day.

24 Comments

  1. Orwellian, isn’t it? They tax my “unearned” income — returns from investment made with after-tax money, and use it to pay an “earned” income credit to people who may not actually work and pay no Federal income taxes at all.

  2. I can remember having negative federal tax liability one year. I was sure I had done something wrong, and spent the last days before the 15th frantically trying to figure out what it was so that the feds wouldn’t come get me (I was both a bit high strung and unjaded back then). Finally I decided that the government really believed I was too poor to live on what I had earned, and that “refunding” more than I paid in taxes was intentional.

    I was insulted, but naturally I accepted the money anyway. I used a small portion of it to buy a case of really cheap beer, which I used to make the recurrent nagging feeling that I was a cheat go away. That worked really quite well.

  3. Dr. Briggs, nice to see you turn your analytical thoughts toward taxes. I look forward to your take on VAT.

    Congress has used a shell game with taxes for many years by steadily increasing taxes other than income taxes. The media seems to ignore changes to those other taxes and focuses only on income taxes. Congress also recognize that these other taxes are regressive and needs a countering mechanism. With no bad press for the increase in “other” taxes, the earned income tax credit looks like a mere gift rather than an appropriate adjustment for high and highly regressive other taxes. It concerns me more that the 1986 Act removed almost all of the incentive for the wealthy to put their money directly into the economy to get a lower effective income tax rate (and bypass the government, by the way). I believe that the ’86 act caused a massive re-diversification of the country’s wealth into the stock market and made the Enron and Madoff types of fraud more possible — and more lucrative for fraudsters. I also believe the re-diversification to be deliberate.

    Once upon a time, I was in the financial offices of a large multinational corporation (in NYC) to review the income tax provision aspect of its annual audit. These were my observations: First, down the hall was a permanent office set aside for the IRS’s use. Second, the tax return included so many subsidiaries that when stacked on the floor it reached the level of the desk. Third, one sole IRS agent who regularly checks on the accounting procedures of the company could easily and immediately ascertain the level of tax withholding compliance for many thousands of employees. The apparent discouragement of small businesses seems to me to be about easier enforcement of the tax code for the IRS. Did the government have the same thought about forcing passive investments to flow through the stock market? If so, they overestimated their own competence to regulate. You often say that people are too confident about what they think they know. Applies well to those in charge, I’d say.

  4. Matt,

    Such shameless pandering to the beleaguered taxpayer on April 15!

    Admit it, you’re a shill for Big Taxpayer. Wait, is that a shill for Small Tax? No, you must be a shill for Big ‘Small Tax’! Yeah, that’s the ticket.

    My wife’s business posted a loss this year. My only consolation is that we’ll get a big portion of my withholding back.

  5. Everyone should pay something. And by Everyone, I mean most of us, except maybe the children and infirm (but I assume that the households in which they live will contribute something). The taxation for the presently un-taxed could be modest, but with Everyone contributing, we will demonstrate some commonality of purpose and shared values, not to mention personal dignity.

    Michael P: Interesting about the regulation (re: discouragement of small business). Briggs touched on regulation in general in part III of Liberal Fascism review, but I believe the topic of regulation and how it is manifested should be widely discussed.

  6. Matt,

    Gross income is misleading. It doesn’t tell us about purchasing power, only that you get more money. But without the context of inflation, price increases, and cost of living, gross income doesn’t tell us how people are actually living.

    Even if I make $5K more this year, if it costs me $6K more to maintain my standard of living, I’m not exactly better off than before.

    The whole “only 50% pay taxes” argument is tired, anyway. Too FOX. It’s more fun to look at PPP vs. total payout to government.

    Add in state/city income taxes, and most people are probably worse off if you factor in cost of living adjustments.

  7. I agree with the thrust of the analysis. However some factors have been omitted. One come from the fact is that the ratio of upper incomes to lower income working peoples incomes has been continually going up. This is not due to higher productivity or contributions of these people in most cases. Raising the minimum wage does not help this as the people generally on minimum wage are either low performers or beginning workers (students part time, etc.). Those in high paying jobs (actors, super athletes, bankers, some in the medical field, investors, some CEO’s, etc.) have been going up and up much faster than the lower paid jobs. While some are clearly worth the increases, certainly most are not (how can a CEO of a company going broke get a bonus). The negative income taxes and other wealth transfer were efforts to compensate for that inequity (many of the lower paid workers are hard working and productive, and actually should get generally more than they do). However, there are several other problems. Three are mentioned next. The first is that the wealth redistribution (by the government) is done in ways that tend to stifle innovation and risk taking. The second has to do with the fact that the government commits and wastes huge amounts of the money, and does a generally poor job with it. The negative factors of government actions and laws which probably keep the total wealth down and the unbalance of the wealth ratio (based on historical values) are both factors that push the need for help for poor working people. Obviously I agree non-working people are a separate case. However there is a third factor not mentioned. This is the fact that a large part of the world has workers that make a far low income than US workers. As long as we had technology and education advantages, that did not hurt too much. As these countries improve their technology base and education, they eat our cake and get many of our good jobs. That is just a fact, and will continue until most of those countried come closer to our level. Then all should be able to do better.

  8. Leonard,

    My biggest issue with the “efficient market” types is that they somehow have convinced themselves that the market necessarily allocates wages efficiently. It’s just not true. I am of the firm belief that the average plumber/electrician/carpenter is deserving of a much higher wage than we currently see. But, hey, no college degree = dumb? Bah.

    I’m with Mike Rowe. And I’m white collar, for the record. I just don’t think that wages necessarily determine value to society the way that so many of my economics professors might have.

  9. Ari,

    Could it be that the “efficient market” types are not so convinced of an efficient market as they are convinced of a really, really inefficient government — at least in the area of distributing resources? Some think the market is better, not that it is ideal. Also, most plans for fair taxes or flat taxes depend too heavily on people of all levels of wealth acting in certain ideal ways for which there is little support in our history.

    I have clients and colleagues who are plumbers, electricians and contractors. The carpenter of your example may be the only one who doesn’t make me wonder why I worked so hard for my credentials. But why isn’t the carpenter a contractor?

    I certainly agree that wages do not indicate value to society. In fact, putting aside the very small percentage of people in artistic fields who make significant incomes, the arts is an area of extreme under valuation both in appreciation and incomes earned.

  10. Leonard,

    Outside of a couple points, I agree with much of what you say. First off, I think much of the disparity in income growth between the very highly paid and the rest of us is a result of rapid money growth and who is able to access it first. Money may be “neutral” in economic parlence, but the rapid and preferential creation of it, and therefore claims on current goods and services, most certainly isn’t. Secondly, while your point on the effect of low overseas wages is a commonly held viewpoint, this effect would be more than compensated for by increased productivity IF capital formation were keeping pace viz-a-viz capital formation overseas. Unfortunately, given the government’s predatory role in this area for many years, this is no longer the case.

  11. The problem with comments on “efficient market” are that as long as the government makes excess rules and laws to try to control it, it is not able to be fully efficient. Many of the big corporations use funds to support politicians to get preference rather than concentrating on efficiency. While we are clearly a productive society, we are far less efficient than we could be without the excess government actions. There is a need for clear rules and laws by government to make systems fair and not do unreasonable things (e.g., overfishing killed some fishing industries), but that is not what I am referring to. Also the ratio of average high to low pay is much lower in the rest of the world, even where very efficient operations are carried out. I agree that most of the low paying working people are underpaid, and the highest paid generally overpaid in this country. Higher education is needed for many activities, but I agree that a skilled person even without a higher education should receive good pay. The key word there is skilled. Many Americans are neither well educated or skilled at anything, and this is part of our problem.

  12. I want to expand on my last statement. If we lack “skilled” workers as well as well educated ones, jobs that use these unskilled people can’t be well paid. Third country workers, with a fraction of the pay, can take those jobs away easily with present communication and transportation technology. If US companies in competition on the world market do not use those cheaper labor sources, they become less competitive and go broke. Thus even low minimum wages do not necessarily protect US jobs. This international pressure also tends to keep even skilled and well educated workers under pay pressures (from increased skilled and well educated low paid workers from say China and India). The only way to maximize US wages and fairness is for people to get as much education as possible, to develop useful real skills, and the government to stop doing negative things (mainly on paperwork requirements, stupid rules, and some misplaced taxes). Even then, we will be limited in wealth until much of the rest of the world gets closer in pay levels. This limitation puts maximum pressure on not over concentrating this wealth at the top.

  13. There is too much government, but is it important to protect US jobs?

    If it is important to protect US jobs then the state is not entirely irrelevant. If you were a pure free marketeer, it doesn’t matter where the jobs are located. So long as I can get cheap goods and can charge a satisfactory rate for my services. Why should we deprive our neigbors from the opportunity to work for our benefit?

  14. Leonard,

    Even if you somehow magically made a market unfettered by regulation, you’d never have a truly efficient one. Never mind that a completely unregulated market is not necessarily “better” for the participants. The goal, as always, is to find the right balance. I, for one, like not having free and unregulated insider trading. Assuming you could get rid of all regulation, large players in the market with greater access to information will ALWAYS beat out the little guy, effectively knocking the hypothesis down.

    Michael,

    Regardless of what they believe, efficient markets hypothesis just doesn’t stack up. And I’m not some anti-market Univ. of Maryland type– I largely believe in some amalgamation of modern neo-classical economics with a mix of Hayek and a few others.

    But when your entire financial economy is based on a theoretical platform that fails even the most basic test, it’s kind of a problem.

    “Also, most plans for fair taxes or flat taxes depend too heavily on people of all levels of wealth acting in certain ideal ways for which there is little support in our history. ”

    There’s also the fact that it’s overwhelmingly difficult to come up with one tax rate that will not cripple the lowest earners while also finding a reasonable rate of taxation for the top earners. Never mind that you NEED some tax shields in any tax code to ensure reasonable amortization, protection against losses, etc. But, as always, that will mean that SOMEONE will manage to get out of paying taxes. Look at how businesses today use insurance as an effective tax shield while paying out lower wages.

    “I certainly agree that wages do not indicate value to society. In fact, putting aside the very small percentage of people in artistic fields who make significant incomes, the arts is an area of extreme under valuation both in appreciation and incomes earned.”

    Well, that may be because most modern art sucks.

    I kid, I kid.

    Doug,

    “If it is important to protect US jobs then the state is not entirely irrelevant. If you were a pure free marketeer, it doesn’t matter where the jobs are located. So long as I can get cheap goods and can charge a satisfactory rate for my services. Why should we deprive our neigbors from the opportunity to work for our benefit?”

    A completely free labor market is great for the one sending the jobs overseas. Not so great for the person whose job goes overseas. Also, I hate foreign call centers. So much.

  15. Ari,

    Are we discussing whether labor makets are efficient, or are we discussing Fama’s “Efficient Market Hypothosis”?

    and does efficient mean rational?

    EMH says that market quicky price in new information. Even more simply, EMH says that markets are difficult to predict. So, if you think that the 2008 crisis refutes EMH, actually quite the opposite. Did you see that sh!tstorm comming?

  16. If we were to shift the income tax to 50% for those people making 100K or less, revenues would marginally increase but the individual burden on that population would go through the roof.

    There is simply not much to understand when, by your graphs, the top 1% makes Gross income of 2x more than the rest of the population combined.

    By Hauser, tax revenues will be ~19.5% of GDP no matter what. GDP is more or less a reflection of the total wealth of the top 1-5% of the population. The revenues simply can’t come from anywhere else. Sure everyone needs to put in their part, but the fact is, the lower and middle class don’t have enough to impact total tax revenue, regardless of how much they contribute.

  17. john,

    No, the top 1% does not make 2 times more than the “rest of the population combined.” The make probably 1.5 times the bottom 50%. I say “probably” because these are adjusted gross incomes and not incomes. Those adjustments are larger for those with low incomes, so that is why the ratio is probably smaller than 1.8.

    Also consider that the rich will be paying more taxes (property especially).

    Plus, graph 3 shows that the top 1% are paying somewhere close to half of all taxes. Half!

  18. I misread your last graph. It shows, as you said the 1% versus the bottom 50%.

    The rest of my post remains intact.
    Raising and lowering the top marjinal tax rate has such a huge impact on that tier of earners and GDP, they quite simply will always pay the largest chunk.

    you stress Half!, but that’s just an arbitrary number, emphasized for impact. It somehow carries more weight than 40% or even 60% because people can visualize it better. If the lower 50% could miraculously cough up 10x their current contribution, the top 1% is still on the hook for the same amount of money. Percent of the total is just a talking point.

  19. Ari,

    “Well, that may be because most modern art sucks.” Agreed, but I should have mentioned performing arts specifically with emphasis on live music and drama (even though “new music” and “new drama” can fall into the same sucky category). My vote for most underrated area in need for reform is in music licensing where we have co-existing monopolies doing precious little to benefit anyone but the organization.

    Re the economy and your astute understanding of same, I generally have a street level view from years of seeing people’s reactions to tax policy rather than to economic policy. (My belief is that every accredited educational system should require at least one course in economics.) You may recall that before passing the 1986 Act it was touted that a certain wealthy family paid $0 taxes one year. During my career in “Big Eight Accounting” (a term now used as a dating method), I happened to review that return. That single return would be a good tool for any tax think tank to compare money going directly into economy without being filtered through the government. I agree with you about the need for regulation, though (and the insider trading example is spot on).

    Briggs, I have a vague recollection of a rule of thumb that said that 90% of our taxes were paid by the top 10%. If that ratio still holds, then not much has changed in the last 30 years regardless of tax rates and disparity of incomes.

  20. “…deductions are a much higher and growing proportion of the incomes of the bottom 50%.”

    Do you care to support this claim by something substantial?

    Regards,
    D[ear] S[ocialist] P[al]

  21. DSP,

    Yes. Take any fixed increase in, say, the standard deduction (which has gone up over the time period presented). Then it is easy to show that this is a larger percentage of the bottom 50%s’ income.

  22. Doug,

    To be clear: both.

    The entire concept of all markets being efficient hinges on the notion that humans act rationally and are “that agents have rational expectations; that on average the population is correct (even if no one person is) and whenever new relevant information appears, the agents update their expectations appropriately.”

    “EMH says that market quicky price in new information. Even more simply, EMH says that markets are difficult to predict. So, if you think that the 2008 crisis refutes EMH, actually quite the opposite. Did you see that sh!tstorm comming?”

    No, it merely says that markets are informationally efficient– that is that they reflect the information available. However, we know this to not be true in a number of cases, the most popularly shown being that stocks with low PE tend to be overvalued. Look at how people react to growth stocks (tech bubble, for example) vs. mature stocks. There are plenty of cases where both individuals and the investing herd (I mean that as nicely as possible) act irrationally despite available information. EMH only applies weakly at best.

    Furthermore, despite Fama’s continued belief in his own argument (shocking!), we know that actors do not always behave rationally nor always have rational expectations. We can also see this in how Lehman, as a popular example, acted toward its own MBS investments. People suffering from cognitive dissonance can act in ways that defy all sorts of logic.

    Furthermore, I think plenty of people saw 2008 coming in some way, shape, or form. There were plenty of people saying that the derivatives markets would blow up. Plenty of trumpets were sounded about sub-prime markets. Whether or not one believed it would be as severe as it has been doesn’t really change the fact that it was pretty easy to say that the lead up was unsustainable. I can’t find it on the forum cloud anymore, but I was saying back in 2005-2006 that sub-prime was going to cause trouble. It was fairly easy to see the if. It was a matter of when.

    Or, we can use the bubble that popped in 2000 if we prefer, because that’s another great example of individual and groups of actors acting in ways that define rational expectations.

    The same applies to labor markets. Any number of inefficiencies exist in labor allocation (and wage allocation). Unions, labor barriers, quotas, certifications, human follies, etc. all interact to ensure that labor markets are not in any way efficient.

    Michael,

    I agree with you on the monopolies. I wonder if the Internet cloud has the power to change that in some ways.

  23. Securites with low P/E ratios tend to outperform, but they are also higher risk.

    Labor markets are hugely inefficient. There is poor information, high transactions costs, and a lot of emotion at play.

    I would say that financial market s are highly efficient. Although, there are informational inefficiencies at play.

  24. One caveat that I haven’t seen elsewhere in this whole 47%-99%-1% tax discussion is that we need to be careful that we don’t make the same analytical mistake Marx did and regard the “bottom 50%” as a permanent, class-system-bound population. In a dynamic capitalist society (which, for the moment, we pretty much remain, in spite of the Obama regime’s best efforts to the contrary), people move up and down the economic ladder more or less continuously. We didn’t even have much of a permanent underclass before it was created by LBJ’s Great Society.

    (I’m not an economist, but the whole “efficient markets” argument puts me in mind of the old line in response to “How’s your wife?” — “Compared to what?” [Oh, that Henny Youngman…])

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