Apr 11, 2017

The fairness of our federal tax system is a hotly debated issue. Too often, however, these debates confuse or misrepresent important facts because they focus on only one part of our federal tax system. To assess whether the tax system is fair or not, it is important to look at the various taxes that people face in aggregate, not just one type of tax in isolation.

This analysis does not focus on individual persons, whose tax burdens differ widely on a case-by-case basis, but instead looks at income groups, on average, to assess the general fairness of the system. The data behind the analysis come from the non-partisan and independent Tax Policy Center, and the Congressional Budget Office.

Effective Federal Tax Rate by Income

Americans pay many types of taxes

One of the biggest misconceptions about the U.S. tax code is that a large portion of Americans do not pay federal taxes. Although it is true that the bottom 40 percent of income earners pay no individual income tax, they face payroll taxes if they are working. In fact, about 80 percent of American taxpayers pay more in payroll taxes than in individual income taxes. Payroll taxes, which help to finance Social Security, Medicare, and unemployment benefits, are the second largest source of federal revenue, and make up about one-third of total receipts annually. Payroll taxes are deducted from workers’ paychecks through a line item called FICA, which stands for the Federal Insurance Contributions Act.

While nearly all Americans pay taxes, the composition of the type of taxes paid is very different for taxpayers at various points in the income distribution. Affluent Americans pay a larger share of their income in individual income taxes, corporate taxes, and estate taxes than lower-income groups.1 By contrast, lower-income groups owe a greater portion of their earnings for payroll taxes and excise taxes than those groups who are better-off. Excise taxes are indirect taxes levied upon transactions of particular goods or activities, such as gasoline, alcohol, or gambling.

The U.S. tax system is progressive

Another misconception about the U.S. tax code is that high-income Americans pay less in taxes because they benefit disproportionately from tax breaks, otherwise known as tax expenditures. While that may be true for certain individuals, in the aggregate the U.S. tax code remains progressive — with higher-income taxpayers paying a larger share of their income in taxes — even after tax breaks have been taken into account.

Major tax expenditures — such as lower rates on capital gains and dividends, deductions for charitable contributions, and deductions for state and local taxes — do tend to benefit high income taxpayers more than lower-income groups. The Congressional Budget Office estimates that the top quintile of taxpayers receive 51 percent — around $445 billion — of the value of major tax expenditures, while only 8 percent — around $70 billion — goes to the bottom quintile. However, even with substantial tax expenditures, the top one percent of American taxpayers still pay an effective tax rate of approximately 31.9%, on average, while the bottom 20 percent of the population pays an average of approximately 3.9%.

The Tax Policy Center estimates that 66 percent of taxes collected for 2016 will come from those in the top quintile, or those earning an income above $147,700 annually. Within this group, the top one percent of income earners — those earning more than $717,900 in income per year — will contribute almost a quarter of all federal revenues collected.

Share of Federal Taxes Paid by Income

As another tax season winds down, many Americans agree that our tax system is complex, confusing, and inefficient. In addition, many economists believe that simplifying the tax code would help the economy. Comprehensive tax reform could promote economic growth, while also making the code more simple, transparent, and fair. The good news is that many promising solutions exist.

1The corporate income tax affects individuals by reducing wages and returns to capital. Based on economic research, the Tax Policy Center attributes 80% of the corporate-tax burden to capital, and 20% to wages and other sources of labor income. (Back to citation)

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