Note: Although I try to keep GRS a politics-free zone, today’s topic is inherently political. I’ve stayed as neutral as possible in the article, but I know that there’ll be some political discussion in the comments. Please keep conversation civil, as always.

Because I was frustrated with my own ignorance about the U.S. federal budget and our tax system, I recently spent twelve hours researching a variety of tax topics. From my research came two articles: last week’s short guide to the federal budget and today’s post, which answers some of my personal questions about taxes.

Note: Though I’ve done my best to be accurate, I’m sure there are errors in this post. As they’re caught, I’ll make corrections.

Last week, we tried to take a few small steps toward understanding the federal budget. We looked at where the U.S. government spends its money. But where does it actually find the cash to spend?

Of the $2.333 Trillion dollars in U.S. government receipts:

  • $1050 Billion (45.0%) comes from Individual Income Taxes
  • $939 Billion (40.2%) comes from Social Insurance/Retirement Receipts
  • $221 Billion (9.5%) comes from Corporate Income Taxes
  • $76 Billion (3.3%) comes from Excise Taxes
  • $20 Billion (0.9%) comes from Estate and Gift Taxes
  • $28 Billion (1.2%) comes from Federal Reserve Deposits
  • $16 Billion (0.7%) comes from other miscellaneous sources

As you can see, nearly half of government receipts come from individual income taxes. Naturally, taxes are a hot-button issue. They have been since this nation was founded. (To be fair, though, the driving force then was “taxation without representation”. Modern complaints are against taxes in principle, I think.)

During my research, several questions about taxes occurred to me. In today’s article, I’ll do my best to share the answers I found.

Is it true that X% of Americans pay no federal income tax?
In a recent discussion about taxes at The Simple Dollar, Kevin wrote:

Roughly half of all Americans don’t pay any income tax at all. I’m sure those folks feel the current tax levels are just fine and dandy, no complaints. Those of us who DO pay taxes, however, are buckling under the weight.

Kevin’s comment left me wondering: Are there really that many Americans who don’t pay income tax? And are those of us who do pay income tax really “buckling under the weight”?

I was unable to locate government data on people who don’t pay taxes. Instead, I found a March 2006 article from the Tax Foundation, a nonpartisan tax research group based in Washington, D.C., which calculated that 43.4 million tax returns resulted in zero (or negative) tax liability. Another 15 million households file no tax return at all. Based on these numbers, the article concludes:

Roughly 121 million Americans — or 41 percent of the U.S. population — will be completely outside the federal income tax system in 2006. This total includes those who pay no tax, and those who pay some tax upfront and are later refunded the full amount of the tax paid or more.

So, according to this study, 41% of the U.S. population lives outside the federal income tax system, and 32% of U.S. tax returns resulted in zero or negative liability in 2006.

This 32% number is relatively high. Previous peaks were at 28% in 1950 and 26% in 1978. Lows were 16% in 1968 and 18% in 1984. In general, the percentage of tax returns with no tax liability is between 20% and 25%.

Note: As several commenters have noted, although some people pay no income tax, that doesn’t mean they pay no federal tax at all. Linear Girl writes: “The second largest source of funds for the federal government is payroll tax, aka Social Security and Medicare. All employed people who aren’t paying any income tax do pay payroll tax of 7.65% on all earned income (their employers also pay and additional 7.65%; if you are your own employer you pay both sides). “

The Tax Foundation sees these numbers as a call to “broaden the tax base”, but admit that nonpayers tend to be younger and earn lower incomes. (Here’s a past GRS article about people who live on low incomes in order to avoid paying taxes.)

If there are a large number of non-payers, does that mean the rest of us are “buckling under the burden”? Let’s look at more numbers.

How do current income tax rates compare with those from the past?
In the United States, the federal individual income tax went into effect in 1913. The top marginal rate was 7% — and that’s if you earned over half a million dollars. (According to the Bureau of Labor Statistics inflation calculator, that’s equivalent to an income of nearly $11,000,000 today!)

Note: The difference between marginal tax rates and effective tax rates can be confusing, even for those who know better. Here’s an explanation of how marginal tax rates work.

The Tax Foundation has published a handy viewer that allows users to explore U.S. federal individual income tax rates from 1913 to 2009. (They offer PDF and Excel versions of the data, too.)

Using their data, I created a graph that shows the history of U.S. marginal tax rates. This graph shows the lowest marginal rate in red and the highest marginal rate in blue. At any one time there are many other rates in between. (The tax tables are simple right now, believe it or not.)

Based on this information, it would be easy to conclude that tax rates are low in the United States right now relative to past history. While I believe this is probably true, it’s impossible to know this for sure without copious data regarding average incomes and effective tax rates. Still, the answer to the next question provides a bit of a response.

What tax rate does the average person pay?
Because the United States has a system of progressive taxation, it’s difficult to know exactly how much each person pays for income tax. We all know our marginal tax rates — the rate at which the last dollar of our income is taxed — but our effective tax rates (or average tax rates) fluctuate from year to year.

I don’t know a source for comprehensive data on this question. The IRS does provide some statistics (and may, in fact, provide all the data one needs), and other parties have taken the time to collate some of it. For example, the Tax Foundation has produced several pages of summary tables. From this info, I built the following chart:

This chart shows the average federal income tax rates over time for a variety of income levels. The red line shows the average tax rate from 1980 to 2007 for the top 1% of the population based on Adjusted Gross Income (AGI). The black lines shows the top 10% of earners based on AGI. The blue line shows the overall average federal income tax rate for all U.S. citizens.

In 1980, Americans paid 15.31% of their AGI in income taxes. In 1990, that number was 12.95%. In 2000, it was 15.26%. In 2007 — the last year for which there is data — that number was 12.68%. Based on this, I’d say that the average American has an effective federal income tax rate of 13-15%. (And top earners pay about 22%.)

Note that these numbers don’t exactly match the statistics for effective tax rates that are available from the Congressional Budget Office. (Which show, for example, an effective individual income tax rate of 11.7% in 1980, 10.1% in 1990, 11.8% in 2000, and 9.1% in 2006.) I’m almost certain it’s a matter of methodology, but I don’t have the time to dig in and discover the details. That last link, by the way, contains loads of great data, some of which is analyzed in this piece at The New York Times.

Note: This graph shows something else, too. Contrary to some arguments, high income earners do pay more in taxes than low-income earners. The bottom half of American wage earners pay an average of about 5% to the federal income tax. The top half pays about 15%. The top tenth of American wage earners pay nearly 20% of their wages in federal income taxes. Again, I’m not saying this is right or it’s wrong, but those with high incomes do pay more in taxes.

So are Americans “buckling under the burden” of taxes? I’m not convinced. Taxes seem to be moderately low right now based on our past history. But maybe we pay more than the rest of the world? Let’s find out.

How does the U.S. tax burden compare with that of other countries?
Though I was unable to locate comprehensive statistics for every country in the wold, the Organization for Economic Co-operation and Development (OECD) does collect data on its 30 member nations.

In fact, you can view 18 years of OECD tax data all on one page. These numbers represent each country’s tax revenue as a percentage of GDP (gross domestic product). These figures include all taxes: federal, state, and local. (Note that you can export the data from this page in a variety of formats! Fun for statsgeeks and taxgeeks alike.) Here’s a graph of the data from 2006, the most recent year for which complete stats are available:

In 2006, tax revenue in the United States was 28.0% of the gross domestic product. Put another way, the average American paid 28% of her income to taxes (state, federal, and local). Of the 30 OECD member countries, only four had lower taxes (Japan, Korea, Turkey, and Mexico). The highest tax burdens were in Denmark and Sweden, where tax revenue was 49.1% of the GDP. The lowest tax burden (by far!) was in Mexico, where tax revenue was only 20.6% of GDP.

These numbers indicate that relative to other countries, the United States has a low tax burden.

How much is this all costing me?
Social Security, Medicare, Medicaid. Food Stamps, Unemployment Compensation. The Army, the Navy, the Air Force, the Marines. And the interstate highway to grandmother’s house. How much does this all cost you?

Well, Jess Bachman (the Death and Taxes poster guy) has done the calculations for you:

The average U.S. taxpayer has an income of $43,650. For every billion dollars of government spending, this taxpayer is on the hook for five bucks. These numbers scale up or down depending on your income. If you earn $100,000 a year, for example, you pay $15 of taxes for every billion dollars the government spends. Ouch.

Conclusion
Based on my research, U.S. taxes actually seem relatively low, both historically and in relation to other countries. I am not arguing that we should have higher taxes. Nor am I arguing we should have lower taxes. I’m just relaying the facts.

In fact, I don’t really have a purpose behind my research other than education. With all of the recent national discussion about taxes, I felt woefully under-informed on the subject. When listening to people argue about taxes, it’s difficult to know whom to believe. I wanted to do my own research and then share the results with you.

For more exciting information about taxes, check out the following:

After all that, how would I balance the budget if I were dictator of the United States? Easy. I’d cut all programs across the board by 10% while increasing taxes on everyone by 10%. Yeah, that sucks, and every citizen of the U.S. would be unhappy. But you know what? If I were dictator, I wouldn’t care. I’d be sitting in a cozy room reading comic books while eating chocolate chip cookies with milk.

Update #1: As with last week’s post, I’ll post updates here at the end of the article as readers offer clarifications or important points. For example, although I focused exclusively on federal income tax for individuals in this article, several readers noted that this is not our only federal tax in the United States. Linear Girl provides a succinct summary: “The second largest source of funds for the federal government is payroll tax, aka Social Security and Medicare. All employed people who aren’t paying any income tax do pay payroll tax of 7.65% on all earned income (their employers also pay and additional 7.65%; if you are your own employer you pay both sides). “ So, if you want to include the complete federal tax burden in the above conversation, you need to add 7.65% to all figures — 15.30% if you’re self-employed.

Update #2: For those requesting a second part to this article about how this money is spent…that was actually the first part, last Monday’s short guide to understanding the federal budget.

Graphs courtesy of me. Images courtesy of Jess Bachman, creator of the Death and Taxes poster. Bachman is generously offering a deal for GRS readers. Order two or more posters and get 50% off when you use the code ’slowly’ at checkout. “It’s basically buy-one, get-one-free,” Bachman says. Thanks, Jess!

This article is about Economics, Taxes  Monday, 31st August 2009 (by J.D. Roth)