Issues & Solutions | Peter G. Peterson Foundation | Our America. Our Future.

One of the most hotly debated issues of our time is the fairness of our federal tax system. But too often, discussions are clouded and confused because they focus on only one part of our federal tax system–usually the individual income tax–and ignore the fact that Americans pay many other taxes, such as the payroll tax, the corporate income tax, and the estate tax. To assess whether the tax system is fair or not, it is important to look at the combined taxes that people pay, not just at one tax.

This approach helps to dispel two misconceptions that have emerged in recent debates about our tax system. The first misconception is that nearly half of taxpayers pay no federal tax. Although it is true that many people pay no individual income tax, they face significant payroll taxes if they are working. In fact, the bottom 80 percent of taxpayers pay, on average, more in payroll tax than income tax. The second misconception is that high-income people face low overall tax rates because they receive most of their income from tax-favored capital gains and dividends instead of wages and salaries. That conclusion, however, does not account for the fact that high-income people bear a disproportionate share of the corporate income tax, which significantly raises their overall effective tax rates.

To illustrate these points, this chart deck focuses on the effective tax rates borne by taxpayers with different levels of income. Effective tax rates take account of the complexity of the tax code, including the statutory tax rate as well as the various tax deductions, exclusions, and credits that reduce taxpayers' liabilities. (Please see the Appendix for tables showing the statutory income and payroll tax rates.) The data in these charts come from the nonpartisan and independent Tax Policy Center.

Effective tax rates: individual income taxes alone
Percent of cash income

SOURCE: TPC, Table T12-0018 Effective Federal Tax Rates by Cash Income Percentile; 2011, February 2012. Compiled by PGPF.
NOTE: A quintile is one fifth of the population. The breaks are (in 2011 dollars): 20% $16,812; 40% $33,542; 60% $59,486; 80% $103,465; 90% $163,173; 95% $210,998; 99% $532,613; 99.9% $2,178,886.

The individual income tax is generally progressive in the sense that the effective tax rate increases as income rises. In 2011, the bottom 20 percent of taxpayers faced an average tax rate of -5.8 percent, which is essentially a tax subsidy.[i] At the same time, the top 1 percent faced an average tax rate of 20.3 percent. However, some taxpayers with very high incomes faced lower effective rates than people with lower incomes because much of their income came from tax-favored capital gains and dividends. Warren Buffet, for example, paid an 11 percent tax rate in 2010.[ii]

Looking solely at income tax burdens, however, is misleading because taxpayers face a number of other taxes. One of the most important taxes for a majority of Americans is the payroll tax, which helps to finance Social Security, Medicare, and unemployment benefits.

Effective tax rates: individual income and payroll taxes combined
Percent of cash income

SOURCE: TPC, Table T12‐0018 Effective Federal Tax Rates by Cash Income Percentile; 2011, February 2012. Compiled by PGPF.
NOTE: *Individual income tax rates for the lowest and second lowest quintiles are negative and are netted against the payroll tax rate. A quintile is one fifth of the population. Calculations assume that employees also pay the employer portion of payroll taxes in the form ofreduced wages. The breaks are (in 2011 dollars): 20% $16,812; 40% $33,542; 60% $59,486; 80% $103,465; 90% $163,173; 95%$210,998; 99% $532,613; 99.9% $2,178,886.

The distribution of tax burden becomes less progressive when we look at payroll and income tax rates together.[iii] Indeed, the effective tax rates at the bottom of the distribution are significantly higher when the rates are combined. Meanwhile the very top rate increases by less than one percentage point largely because the payroll tax does not apply to wages above a certain threshold (which is $110,100 in 2012).

However, this second chart does not include two other important sources of revenue for the federal government: the corporate income tax and the estate tax. The estate tax, by design, impacts the wealthiest Americans, who tend to be at the high end of the income distribution, and generally does not apply to estates below $5 million. Determining who pays the corporate income tax, however, is more complicated. Although evidence is mixed about how much of the corporate tax is borne by investors or shifted to workers, the weight of the evidence indicates that the corporate tax burden falls primarily on investors. For that reason, the Tax Policy Center allocates the burden of the corporate tax in proportion to the taxpayer's share of capital income.

Effective tax rates: income, payroll, corporate and estate taxes combined
Percent of cash income

SOURCE: TPC, Table T12‐0018 Effective Federal Tax Rates by Cash Income Percentile; 2011, February 2012. Compiled by PGPF.
NOTE: *Individual income tax rates for the lowest and second lowest quintiles are negative and are netted against the payroll tax rate. A quintile is one fifth of the population. Calculations assume that employees also pay the employer portion of payroll taxes in the form ofreduced wages. The breaks are (in 2011 dollars): 20% $16,812; 40% $33,542; 60% $59,486; 80% $103,465; 90% $163,173; 95% $210,998; 99% $532,613; 99.9% $2,178,886.

Viewed in aggregate, our tax system is generally progressive, with higher-income taxpayers paying a larger share of their income in taxes. However, taxpayers at different ends of the income distribution pay different types of taxes. For low-income Americans, the payroll tax is the dominant tax; for high-income Americans, individual and corporate income taxes are important parts of their effective tax rate. Although the Tax Policy Center does not provide estimates of effective tax rates beyond the top 0.1 percent of taxpayers, a 2005 study by the Congressional Budget Office found that effective tax rates within this group declined slightly as income rose to the very top of the distribution.[iv]

This analysis does not include federal excise taxes on products like gasoline, diesel fuel, tobacco products, airline tickets, and alcohol, which disproportionately impact lower-income taxpayers, who devote more of their income to consumption, or state and local income, property, and excise taxes. Including those taxes would flatten the progressivity of the tax system somewhat, but it would not fundamentally alter the basic conclusions of this chart deck.[v]

Appendix

The following three tables provide additional detail about the individual income tax system, the corporate income tax system, and the payroll tax. The individual income tax table includes information only for married couples filing jointly; there are different tax rate schedules for singles, heads of households, and married filing separately. For more information about those tax schedules, see the compete individual income tax parameters.

Federal individual income tax rates for married couples, filing jointly, 2012

SOURCE: Joint Committee on Taxation, Overview Of The Federal Tax System As In Effect For 2012 (JCX 18‐12), February 24, 2012.

Federal corporate income tax rates

SOURCE: Joint Committee on Taxation, Overview Of The Federal Tax System As In Effect For 2012 (JCX 18‐12), February 24, 2012.
* The first two graduated rates described above are phased out for corporations with taxable income between $100,000 and $335,000. As a result, a corporation with taxable income between $335,000 and $10,000,000 effectively is subject to a flat tax rate of 34 percent. Also, the application of the 34‐percent rate is gradually phased out for corporations with taxable income between $15,000,000 and $18,333,333, such that a corporation with taxable income of $18,333,333 or more effectively is subject to a flat rate of 35 percent.

Payroll tax rates for 2012: Social Security, Medicare, and unemployment

SOURCES: Social Security Administration, The 2011 Annual Report of the Board of Trustees of the Federal Old‐Age and Survivors Insurance and Federal Disability Insurance Trust Funds, May 2011, and Center for Medicare and Medicaid Services, 2011 Annual Report of the Boards of Trustees of the Federal Hospital Insurance Trust Fund and the Federal Supplementary Medical Insurance Trust Fund, June 2011.
* The normal rate is 6.2%. For 2012, a reduction (" payroll tax holiday") is in effect.
** The statutory rate is 6% on wages up to $7,000, but the employer receives a credit of 5.4% for payments to state unemployment funds. As a result, the federal government receives a maximum of $42 per worker.

Download the PDF