Tuesday, March 30, 2010

Should the Rich pay more taxes?

I suggested in an earlier blog that the recent healthcare reform is part of a bigger agenda to redistribute income and wealth in the USA. I just saw a television interview with Howard Dean, a Democrat and a former presidential candidate who confirmed the idea. The widely held belief is that under President George W. Bush (or perhaps longer) the distribution of income changed in such a way as to move income from the poor to the rich. Therefore, the argument goes, it is okay to tax the rich more so as to provide healthcare benefits to those in lower income brackets.
Data from the IRS do not confirm the widely held belief that the rich have somehow escaped an increasing tax burden. If anything, the tax burden on the rich has grown while the tax burden of the poor and those with middle incomes declined. Of course, there might still be an argument that these relative burdens should have changed even more.

Read on for the details of my analysis of the IRS data.
The above link will take you to a report summary and details presented in 10 tables. The tables contain relevant income and tax data for each year between 1980 and 2007. Given the limited room we have here, I decided to focus on comparisons over a 10-year time period from 1997 to 2007. Of course, results could differ depending on which years are compared and the reader is invited to use the data to further the discussion. Briefly, both 2007 and 1997 were years of strong economic growth. While 2007 was the end of a long expansion period, 1997 was not the terminal period of a similar long expansion.
All the data discussed here comes from income tax returns. Thus, it does not include any direct data on wealth. Since adjusted growth income (AGI) does include income from assets as well as labor, it is a fairly broad measure of income. The data reported includes tax return filed that reported a positive AGI – whether or not they paid anything in taxes. Some paid zero (meaning they received back anything that was withheld) in taxes. AGI does not include government transfer payments and other non-taxable income sources.
To facilitate the discussion, I compare three groups – those in the upper 10% of the incomes (Rich), those in the lower 50% (Poor), and everyone else (Middle). I recognize there are many ways to define the rich, poor and middle. To be in the upper 10% in 2007, you had to make more than $113,080. To be in the bottom 50% you could make no more than $32,879.
The details are below, but here are the three main points of the decade comparison -- 1997 to 2007:
1. While the Rich had large income increases, their share of income taxes rose proportionately more to where they accounted for 71% of all incomes taxes paid in 2007. Thus, 10% of the filers paid 71% of the income taxes. They accounted for 43% of AGI reported.
2. The Poor’s income rose during the decade, but the lower 50% of filers fell further behind the rest of the population. This 50% of the population accounted for only 12% of income reported in 2007. They contributed only about 3% of all taxes, however, down from more than 4% in 2007.
3. I constructed a measure of taxes paid relative to income reported and found that the share of taxes the Rich paid was 48% more than their equal share of taxes (if their tax share was equal to their income share). That was roughly constant over the decade. In contrast, the Poor paid about 25% less than their equal share of taxes (if their tax share was equal to their income share). This was down from about 31% in 1997. That is, in 2007 the Poor earned 12% of the income but only paid 2.9% of the taxes.
In 1997, the following was recorded:
· 121.5 million tax returns were filed, with AGI of about $5 trillion and paid income taxes of about $730 billion.
· The Rich (according to my definition) accounted for 10% of the filers, 43% of the income, and 63% of the income taxes.
· The Poor accounted for 50% of the filers, 14% of the income, and 4.3% of the taxes paid.
· Middle accounted for 40% of the filers, 43% of the income, and about 37% of the taxes.
Some metrics – The Poor compared to the Rich had 5 times the number of returns, one-third the income, about 7% of the taxes paid. Summary of metrics – there were many more returns filed by the poor, they accounted for a very small share of the income, and an even smaller share of taxes. If 100 signifies an equal share of taxes to income – then the score of the Poor was 30.7. The score for the Rich was 147. This is one way of measuring the progressivity of the income tax.
Next, let’s see how these metrics changed between 1997 and 2007
· The number of tax returns increased to 141.1 million – an increase of about 16%. The overall USA population increased by about 13% over those years. AGI rose by $3.8 trillion or by about 76%. Income taxes increased $390 billion or by about 53%. The average income tax rate for the USA went from about 14.6% in 1997 to about 12.7% in 2007.
· Rich (as defined by the upper 10%) received 48% of the income and paid 71% of the taxes. Comparing to 1997, the share of income going to the Rich increased by 5 points (from 43% to 48%) and their share of income taxes increased by 8 points (from 63% to 71%).
· Poor (as defined by the lower 50% of the filers) reported 12% of the income and paid 2.9% of the income taxes. The share of income of the Poor fell from 14% to 12% while their share of the taxes declined from 4.3% to 2.9%. Their share accounted for 2 points less of the income and 1.4 points less of the taxes paid.
· Middle’s share of income fell by 3 points from 43% to 40% while their share of taxes declined 6.6 points from 32.7% to 26.1%.
Over these 10 years the income share of the rich rose by 5% -- with the share of the Poor and Middle declined together by 5%. The tax share of the rich increased by 8% while the other 90% of the population saw their share of all taxes declining by a total of about 8%. If we compare income to taxes, the Rich’s score rose slightly to 148; the Poor’s score decreased to 24.2; Middle’s score fell from 76 to 65.


  1. I've always wondered what legal gymnastics were utilized to square our progressive income tax brackets with the 14th Amendment's Equal Protection Clause. But I just discovered that the Clause applies only to the states and not the Federal government. So there goes that theory.

    But I still believe that a progressive income tax does not jibe with the Founders' intentions. That and 4 bucks will get you a latte at Starbucks.

    I'd love to see a Flat Tax. Not holding my breath however. Second dream would be to do away all the tax credits. Just another form of income redistribution.

    In my ideal world, as long as we have an income tax, you MUST pay some tax. Every citizen who works should pay into the Treasury to 1) increase the tax base, 2) extract a price from every citizen for the privilege of being an American, and 3) increase skepticism among the electorate that Washington will spend the money more wisely than the wage earners.

    So anyway, I'm in the middle of a career pivot and am actually taking the accounting classes to sit for the CPA exam. And coincidentally, I'm in the Federal Income Tax class right now. Holy Cow! And with ObamaCare coming down the pipe, the Tax Code won't be getting any simpler soon. Looks like I picked the right field.

  2. Kinda off topic, but what ever method is used to collect taxes the plain fact of the matter is current tax revenues don't come close to covering current expenditures.

    Without rational spending by the govt I don't see a rational system of tax collection happening.

  3. This link may be of interest


    Just a poll, but it does show what peeps think about who pays the most taxes.

  4. I'm not sure what your point is in this article unless it is that we have been doing income transfer for many years and Howard Dean is just proposing to accelerate it. But he may be reaching for something that is only marginally attainable.

    The March 30 WSJ had an Op-Ed by Alan Reynolds of the Cato Institute that argues (with study data data to support his thesis) that increasing tax rates to further squeeze the "Rich" is self-defeating because the Rich can and will take (legal) steps to avoid not only the increased taxes but also those that they are NOW paying.

    If that is true (and I'm sure that it is from my old days doing tax returns for Rich), then since they are already spending the money, the increased taxes will end up having to come out of the hides of the Middle.

    So much for campaign promises ...

  5. Thanks for the post Jim. One of my goals in this blog is to bring data to people. Too often we are stuck with interpretation without an access to the numbers. So I linked you to some interesting numbers. A second purpose is to focus on some key numbers. I don't always want to be the one to draw the conclusions. I like putting out some facts or models and let the rest of you draw your own conclusions. For example, I emphasized that the upper 10% of the tax payers paid 71% of all income taxes in 2007. My liberal friends would say -- "Is that all?" Other friends might see this as a negative thing -- you quote Alan Reynolds pointing out the disincentive/avoidance effects of higher tax rates. Third, I like to get away from name-calling and focus on the issues. Reynolds has a good one -- will the increased taxes on the wealthy lead to a bigger burden on the rich or the middle? Let's bring some facts to that question...or others that come to mind.

  6. The total cost of the Earned Income Tax Credit was about $40 billion in 2008. Applying that figure to the 2009 numbers in the table (which do not include the EITC) leaves the bottom 50% with a negative average tax rate (roughly -0.7%).

  7. Richard, thanks for the update. Did you mean 2007 and not 2009?

  8. Playing devil's advocate (cuz I am definitely not a lib); the argument is often made that while the poor (by what ever measure) often seem to get a break on income tax they get hit hard by other taxes. FICA, SS, SSI, sales taxes, property taxes, car fees, gas taxes, and sin taxes take a much larger share of of the poor's income than the rich's income.

    As I posted earlier current tax revenue from all sources do not reach the level of current expenditures resulting in inflation; which I still claim is the worst tax of all.

    My analysis is until tax revenue exceeds govt expenditures our tax system will remain broken. My answer is not so much to increase the tax revenue, but to limit the expenditures.