The fairness of our federal tax system is a hotly debated issue. Too often, however, those debates confuse or misrepresent important facts because they focus on one type of tax in isolation rather than the various taxes that people face in aggregate. This analysis looks at income groups, on average, to assess the general fairness of the overall tax system. The data behind the analysis come from the non-partisan and independent Tax Policy Center, and the Congressional Budget Office.
This analysis uses data from 2016; such data for 2017 are not yet available. As such, it does not reflect the effects of the Tax Cuts and Jobs Act (TCJA), which was enacted in December 2017 and lowered tax rates for individuals and corporations.
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.
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.
Although the TCJA changed tax rates and other elements of the tax code, the system remains complex, confusing, and inefficient. In addition, many economists believe that simplifying the tax code would help the economy. Further tax reform could promote economic growth, while also making the code more simple, transparent, and fair.
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)