Does the US have a “progressive taxation” policy at the federal level?

paycheck

This came up during a social media conversation. One of my friends posted an article from Wall Street Journal (Saunders, 2018) with the title screaming, “Top 20% of Americans Will Pay 87% of Income Tax.” The article seemed to me intended to outrage higher earners who will pay the bulk of income tax contributions and therefore, carry the rest of the country on their backs. The article did not mention other forms of taxation, which people who do not earn enough to pay income tax in the US, still pay.

The distinction is important for me as a result of comments made by Mitt Romney when he was a presidential candidate in the 2012 race, deriding the 47% of Americans who do not pay income tax as entitlement-claiming victims who will always vote Democrat. (Moorhead, 2018) Many voters found his comments insensitive, as a large proportion of these 47% of people also work full-time at an hourly rate and have federal payroll tax deducted from their paycheck. Often these people do not meet the minimum income threshold for additional income tax liability.

By doing this research, I wanted to check whether the entire taxation picture for all US citizens is indeed “progressive” or not. When I was an Army officer I had an additional duty of Tax Officer. I used to help soldiers in my company file their income taxes so they wouldn’t have to go to H&R Block and pay fifty bucks. I enjoyed it and it gave my inner nerd a chance to shine.

My verdict:

The entire federal US taxation system is broadly progressive, although it’s hard to understand its effects when looking at comprehensive household income for people in various income brackets.

My calculations (assuming they are correct hahahaha) show that the households who pay only payroll taxes are nearly covering the same proportion of the raw contributions to the federal budget, at least in 2016. This is amazing!

Whether one believes progressive taxation is a good thing or not largely depends on a person’s values and what society one wants to live in. If data is something that lights your fire, at least one reputable study shows a strong correlation between progressive taxation in a country and the happiness level of its citizens.

What is “progressive” taxation?

The Wikipedia page on this is quite informative (see Sources below.) Broadly speaking it means as a taxable sum increases, the amount of tax burden on that sum increases. Wikipedia states, “Progressive taxes are imposed in an attempt to reduce the tax incidence of people with a lower ability to pay, as such taxes shift the incidence increasingly to those with a higher ability-to-pay.”

Often in terms of income tax, a certain amount of income is exempt from taxation, up to a certain amount is taxed at a flat rate for everyone, and any amount over that will fall into higher-taxed “brackets,” with the percentage required increasing for each bracket.

Tax included in a discussion of progressive tax doesn’t have to include only income tax. The US government collects revenue in forms of corporate, estate, Social Security, Medicare, and excise taxes. It can also include state and local taxes, but I’m not going there!

What are the primary sources and proportions of US federal government revenue?

Please see the Tax Policy Center links for more details.

The primary source of revenue in FY 2016 for the federal government was indeed income taxes, at 47.3%.

Next were:

  • 34.1 Payroll taxes
  • 9.2% Corporate income tax
  • 2.9% Excise taxes
  • 6.5% Other (includes estate and gift taxes, customs taxes and Federal Reserve deposits)

All working people, including the self-employed, pay payroll taxes. All people who purchase tobacco, alcohol, and gasoline pay excise taxes.

According to the Tax Policy Center in 2016, (Williams, R., 2016)  26.4% of households paid payroll taxes only. My rough calculation (see Notes) shows that these households covered about 23.3% of all the federal revenue collected. If my calculations are correct, these households are pretty much pulling their weight in terms of contributions. The trouble with ideology kicks in with the benefits and tax credits some of these folks receive. Some people believe they aren’t fair.

What are “payroll taxes”?

Payroll tax includes Social Security and Medicare contributions. All working people earning wages pay these taxes. For 2017, the Social Security taxable maximum was $127,200 [annually] (Frankel, 2017). If you earn more than this, you don’t pay Social Security on that marginal amount.

Medicare is taxed at the same rate for everyone up until $200,000 (Frankel, 2017). So any amount earned beyond that will drive a small increase in amount withheld from the paycheck.

What is the proportion of household taxation paid by those who only pay payroll tax?

This is devilishly difficult to figure out and it seems there are plenty of figures available for taxation subtracting benefits, but not including household income.

I’ll try to do the simplest simulation possible on a single wage-earner, assuming the person does not purchase alcohol, tobacco or gasoline and therefore pays no excise tax. The person does not claim dependents.

10, 399                Gross annual income (10,400 is the threshold for income tax filing)

-644.74               Social Security contribution @ 6.2%

-150.79               Medicare contribution @ 1.45%

Total tax bill: 795.53. This implies a 7.65% tax liability on gross annual income.

This person has then 9603.47 left over to live on for a whole year, theoretically. Lucky him or her!

How does the tax burden as a proportion of household income compare, payroll tax payers only vs. income tax payers?

I have to do a little comparative simulation again on the most boring income tax filer ever, who is single, can’t take anything but the standard deduction etc. I’m using the Tax Foundation table on tax brackets (Pomerleau, 2016).

 

100,000              Gross annual income (this seems like a liveable amount at the 28% bracket, and 6,350 is exempt)

-19,203               Income tax bill

-6200                   Social Security contribution @ 6.2%

-1450                   Medicare contribution @ 1.45%

Total tax bill: 26,853. This implies a 26.8% tax liability on gross annual income.  This person has 73,147 left over to live on, theoretically. Lucky him or her!

This simple simulation gives some evidence that the tax system for all people earning wages is progressive. The Tax Policy Center makes the same conclusion when considering taxation mitigated by benefits and credits, not a proportion of total household income (Williams, R.C. 2016). Some people believe that offsetting payroll taxes with various tax credits means these people have a net-zero contribution to their society.

Who are the people who don’t pay income tax? How much “free stuff” are they getting?

Forbes provides a really interesting breakdown though (Williams, 2016):

  • 60 percent of those who pay no income tax will work and owe payroll taxes.
  • Most of the other 40 percent are retirees whose income is too low to owe income tax. One assumes that they worked their entire lives or don’t work at all.
  • Of those who work, two-thirds will have payroll tax liability in excess of any refundable income tax credits.
  • Thus, only about 9 percent of households have their payroll tax fully (or more than fully) offset by those refundable credits.

For those who assert that people whose payroll taxes are offset by refunds, pay “nothing” toward their society, they are correct for nine percent of American households.

Is “progressive” taxation a good thing or a bad thing?

This is an emotional question of one’s fundamental values. I have heard some people complain that poor people “pay nothing” but get all the advantages of a developed society such as infrastructure, public education, and defense. My humble personal opinion is that a stable society depends on working people who contribute their labor and pride in having a purpose in life. Additionally, that person’s labour contributes to mention fulfilment of the business owner’s dream, shareprice for shareowners, the overall economy etc. Their labor is not “nothing!”

There has been a considerable amount of attention research recently into income inequality in developed economies and the numbers are out there for those who are interested in the trends. I happen to live in one of the most income-equal countries in the world as measured by the Gini coefficent, Sweden. By many measures it’s a great place to live and we Scandinavians regularly top the happiness lists, but my research shows that there is a weak statistical correlation between the Gini coefficient and overall happiness in a country.

My opinion only: do you believe everyone should have broadly the same minimum standard of living in the society you live in, and whatever someone chooses to do beyond that is up to them? If you believe it’s acceptable for people in your country to live in destitution even if they work hard, with all the other potential implications that might have such as crime, substance abuse, sheer waste of human capital, etc. perhaps you believe it’s onerous for those with a greater ability to contribute to the society should do so.

I am doing my best to stay neutral here. I reckon most people, regardless of their income level, would be much happier living in say, Scandinavia than they would in a country without the benefits provided by progressive taxation, income equality and a formal economy. I consider the “pillars” of a optimal society for good quality of life to be: infrastructure, a clean environment and water, universal healthcare, education including university level, social security, good police and defense. These make for a peaceful society where everyone has the ability to succeed if they work hard. Whether these pillars are possible without progressive taxation, I am not sure. But guess what, at least one study I found shows a correlation between progressive taxation and overall happiness! (Oishi, S., Schimmack, U., & Diener, E., 2012)

Just for fun: What about very wealthy US citizens who pay comparatively little income tax?

Wealthy US citizens have the means to structure their wealth in legal constructs such as trusts, as well as to move some of their wealth to jurisdictions where it will not be taxed by the US government. Even some wealthy people who don’t take these measures can earn a significant proportion of their living through capital gains on their investments. Capital gains are taxed at a much lower rate than earned income is (see Salary.com article), with the rationale that this policy stimulates investment in the US economy as a whole.

My personal opinion only: It’s certainly nice to have had the advantages in life which allows one to earn a living this way, either through having sufficient support, resources and education to start your own business, have the knowledge to save and invest wisely, to have inherited a fortune, or all of these things. I don’t begrudge these people their fortune. It’s important to feel that one has the possibility to get ahead if one studies and works hard, and if you have saved and worked hard you want to be able to leave something for your children when you pass away.

Whether or not I believe very wealthy can afford to pay more tax, I disagree with the disparaging attitude and conviction that someone got that fortune because he or she is a “winner” and poor people are lazy “losers.” It’s also important to acknowledge that not everyone has significant advantages in life from a very early age, and we should not be disrespectful of people because they have not. So much pure human capital, which could benefit all of us for generations to come, is wasted on potentially brilliant kids who live in poverty. We can only guess at how much.

Also for fun, an international perspective on every day taxation for a typical middle-class person.

As a “higher” earner in Germany, my income was taxed at 48%. There were no additional income taxes. Sales tax applies to everyone and when I lived there it was 18% (I believe). I paid 50% of my health insurance costs, my employer paid the other half. My healthcare was bloody brilliant, best I’ve ever had.

In the UK my income tax was 35%. We also were required to pay council tax each month, which was rated based on the categorical “niceness” of our residence, regardless of whether rented or owned. VAT was 18% most of the time I lived there. Healthcare was free and I was lucky enough to have an employer who offered a supplemental policy as a benefit. I paid for this myself.

In Sweden my income is taxed at 39.5%. We do not have state taxes. VAT is 25% on most items (I believe less for groceries?) Healthcare is free with a small co-pay for each visit up to SEK 1500 per year. Some employers offer a supplemental healthcare policy as a benefit, which allows you to access private specialist services more quickly. I didn’t choose to purchase this.

Sources:

Saunders, L. (2018, April 6). Top 20% of Americans Will Pay 87% of Income Tax. Retrieved April 10, 2018, from https://www.wsj.com/articles/top-20-of-americans-will-pay-87-of-income-tax-1523007001

Moorhead, M. (2012, September 18). Mitt Romney says 47 percent of Americans pay no income tax. Retrieved April 10, 2018, from http://www.politifact.com/truth-o-meter/statements/2012/sep/18/mitt-romney/romney-says-47-percent-americans-pay-no-income-tax/

Progressive Tax. (n.d.). Retrieved April 10, 2018, from https://en.wikipedia.org/wiki/Progressive_tax
No author cited

Williams, R. (2016, September 6). Most Americans Pay More Payroll Tax Than Income Tax. from http://www.taxpolicycenter.org/taxvox/most-americans-pay-more-payroll-tax-income-tax

Frankel, M. (2017, April 12). 2017 U.S. Payroll Tax: What You Need to Know. Retrieved from https://www.fool.com/taxes/2017/04/12/2017-us-payroll-tax-what-you-need-to-know.aspx

Tax Policy Center. (n.d.). What are the sources of revenue for the federal government. Retrieved April 10, 2018, from http://www.taxpolicycenter.org/briefing-book/what-are-sources-revenue-federal-government
Cites Office of Management and Budget, Table 2.1 https://www.whitehouse.gov/omb/historical-tables/

Pomerleau, K. (2016, November 10). 2017 Tax Brackets. Retrieved from https://taxfoundation.org/2017-tax-brackets/

Williams, R. C. (2016, August 11). Federal Taxes Are Very Progressive. Retrieved from http://www.taxpolicycenter.org/taxvox/federal-taxes-are-very-progressive

Williams, R. (2016, July 12). A Closer Look At Those Who Pay No Income Or Payroll Taxes. Retrieved from https://www.forbes.com/sites/beltway/2016/07/12/a-closer-look-at-those-who-pay-no-income-or-payroll-taxes/#53b96d2c5696

Oishi, S., Schimmack, U., & Diener, E. (2012). Progressive taxation and the subjective well-being of nations. Psychological Science, 23, 86-92. Retrieved from http://journals.sagepub.com/doi/abs/10.1177/0956797611420882

Why Mitt Romney & Other Wealthy Investors Pay Less Taxes. (n.d.). Retrieved April 10, 2018, from https://www.salary.com/why-mitt-romney-other-wealthy-investors-pay-less-taxes/

No author or publishing date visible on page.

Note and calculation:

According to the Tax Policy Center in 2016, (Williams, R., 2016)  26.4% of households paid payroll taxes only. Payroll taxes (see below, are paid by all who earn wages, so some, but not all people who pay income tax also pay payroll tax.)  My rough calculation (see Notes) shows that these households covered therefore about 25.5% of all the federal revenue collected.

In 2016, 7.2% of households paid income tax but no payroll tax (because they have non-wage earned income). This means 92.8 of all households paid payroll tax.

Assuming payroll-tax-only households purchase the same proportion of goods subject to excise taxes as those who pay income tax and they are very unlikely to pay the “Other” types of taxes, their share of the federal collection plate is the proportion of payroll taxes they paid plus proportion of excise taxes paid.

((.341 x .928) – (.341 x .264)) + (.029 x .264) = (.316-.09) + .007, which comes to 23.3%.

[proportion of payroll taxes paid by those who paid income tax also] – [proportion of payroll taxes paid by those who ONLY paid payroll taxes] + [proportion of excise taxes paid by those who only paid payroll taxes]