5 Myths about Federal Taxes

My colleague Bob Stoker walked into my office yesterday and, apropos of Andy’s post about Greg Mankiw, noted that there sure was a lot of misinformation about taxation. I suggest he write a corrective, and here it is.

Myth #1: Federal taxes are higher than they have ever been.
According to the Congressional Budget Office (CBO), the opposite is true. Budget analysts typically measure the federal tax burden as a proportion of GDP because this accounts for the amount of our economic output that is devoted to paying federal taxes as the economy grows or contracts. Federal taxes from all sources were 14.8% of GDP in 2009 and are projected to be 14.6% of GDP in 2010. See the CBO report, “The Budget and Economic Outlook: An Update,” August 2010, Table 1-2 (pdf).
By comparison, the lowest tax burden during Ronald Reagan’s Presidency was 17.3% of GDP. Under President Bush federal taxes reached their low point at 16.3% of GDP. See the CBO historic budget tables: http://www.cbo.gov/budget/data/historical.pdf
Myth #2: People at the top of the income distribution pay more than half of their incomes in federal taxes.
According to the Tax Policy Center, the average federal tax rate in 2009 (including income taxes, payroll taxes, estate taxes, and corporate taxes) among the top 20% of the income distribution was 22.9%. Among the top 1% of the income distribution, 26.1%; among the top 0.1 % of the income distribution, 27.9%. The top one tenth of one percent of the income distribution paid an average federal tax rate of less than 28%.
Myth #3: Poor people don’t pay taxes.
It would be more accurate to say working poor families with several children don’t pay federal taxes. According to the Tax Policy Center, the average federal tax burden on the bottom 20% of the income distribution is negative…that means, people in this income range typically get more money back from the federal government than they pay in federal taxes. However, this is a consequence of the Earned Income Tax Credit (EITC) and the Child Tax Credit. For most families the most generous benefits are provided by the EITC and you must work to receive this credit. The current value of the credit is $5,657 for families with three or more qualifying children. Although modest EITC benefits are available to childless taxpayers, the credit is much more generous for families with children. When the generous benefits that are provided for working poor families are aggregated with others in the bottom 20% of the income distribution, the overall federal tax rate for this group is negative.
Myth #4: Federal marginal tax rates always go up as income increases.
The marginal tax rate is the rate that is applied to the last dollar of taxable income. Although it is generally true that federal marginal tax rates increase with income (because the personal income tax is progressive), this is not always true. The FICA tax that supports Social Security and Medicare is a significant portion of the federal tax burden for many taxpayers. The part of the FICA tax that supports Social Security (a 6.2% tax on earned income that is paid by employees and employers) has an income cap (currently $106,800). Earned income above that cap is excluded from the tax. Beyond this, at present unearned income is entirely excluded from the FICA tax (though this is scheduled to change for the part of the FICA tax that supports Medicare under provisions of the federal health care reform). Because most calculations of the federal tax burden include both the employer’s and employee’s share, moving earned income just above the cap reduces the federal marginal tax rate by 12.6%. Here is a history of FICA tax rates from the Social Security Administration.
Myth #5: Only affluent people pay federal taxes.
It is true that people in the top 20% of the income distribution provided 67.2% of federal tax revenues in 2009. However, they receive 54.3% of cash income. Despite this however, most American households pay a share of the federal tax burden. Although 47% of households paid no federal income taxes, two-thirds of these households did pay social insurance taxes to support Social Security and Medicare. The “deadbeats” who paid neither tax were mostly elderly people and people with annual incomes below $20,000. See again the analysis of the Tax Policy Center:

4 Responses to 5 Myths about Federal Taxes

  1. Gnash Equilibrium October 14, 2010 at 10:54 am #

    A minor correction: in myth #4, the “part of the FICA tax that supports Medicare under provisions of the federal health care reform” is neither part of the FICA tax nor dedicated to Medicare. The 3.8% “Medicare” surtax on unearned income over $200k/250k is just an added income tax that goes into the general fund. It has absolutely no direct connection to Medicare.

  2. Vacslav October 14, 2010 at 11:23 am #

    Mankiw makes none of the statements that you guys label as “misinformation” and subsequently “correct”.

  3. John Sides October 14, 2010 at 2:26 pm #

    Vaclav: The general reaction to Mankiw’s piece just got Bob thinking about the topic, and I suggested a more general primer. As is clear in the post, neither Bob nor I am making any claims about Mankiw per se.

  4. Gimlet October 14, 2010 at 2:31 pm #

    Interesting set of correctives, but if they’re aimed at Mankiw they’re off-target. Mankiw was looking at the total tax burden on an individual in his income range – that is, the suite of taxes that come in before he’s left with the money he can actually spend (or, like his example, bequest).

    So, for instance, with Myth 1, the corrective looks at only federal income rates, but the individual pays federal, state (and in NYC, city) – and if a homeowner, pays property taxes (which really did skyrocket during the bubble and have not all been corrected
    downward). On what he wants to spend, he pays sales tax. On what he wants to bequest (above exclusions), he pays the inheritance tax. So the total tax rate for an individual is much higher than just the federal rate, even if the federal rate is the biggest single component. So corrective 2, also, doesn’t get at Mankiw’s point, or even at the intuition many people have that “the rich” pay more than half their incomes in taxes.

    On Myth 3, if it were restated that “poor people net out more in benefits than they pay in taxes” I think you’d find a different answer again – and also confront what is really the intuition of the people to whom Myth 3 is attributed.

    Also, I could be wrong here, but I believe there was a jump from using only federal income tax to show the amount of tax burden in point 1, but then Social Security/Medicare et al were included to show that the poor paid taxes and for the marginal rate point.