Effective tax rates in the United States

Effective tax rates in the United States

I messed up! Despite trying to make this article as fact-based as possible, I botched it. I've made corrections but if you read the comments, early responses may be confusing in light of my changes.

For the most part, the world of personal finance is calm and collected. There's not a lot of bickering. Writers (and readers) agree on most concepts and most solutions. And when we do disagree, it's generally because we're coming from different places.

Take getting out of debt, for instance. This is one of those topics where people do disagree — but they disagree politely.

Hardcore numbers nerds insist that if you're in debt, you ought to repay high-interest obligations first. The math says this is the smartest path. Other folks, including me, argue that other approaches are valid. You might pay off debts with emotional baggage first. And many people would benefit from repaying debt from smallest balance to highest balance — the Dave Ramsey approach — rather than focusing on interest rates.

That said, some money topics can be very, very contentious.

Any time I write about money and relationships (especially divorce), I know the debate will get lively. Should you rent a home or should you buy? That question gets people fired up too. What's the definition of retirement? Should you give up your car and find another way to get around?

But out of all the topics I've ever covered at Get Rich Slowly, perhaps the most incendiary has been taxes. People have a lot of deeply-held beliefs about taxes, and they don't appreciate when they read info that contradicts these beliefs. Chaos ensues.

Tax Facts

When I do write about taxes — which isn't often — I try to stick to facts and steer clear of opinions. Examples:

  • The U.S. tax burden is relatively low when compared to other countries.
  • The U.S. tax burden is relatively low when compared to U.S. tax burdens in the past.
  • Overall, the U.S. has a progressive tax system. People who earn more pay more. That said, certain taxes are regressive (meaning that, as a percentage of income, low earners pay more).
  • A large number of Americans (roughly one-third) pay no federal income tax at all.
  • Despite fiery rhetoric, no one political party is better with taxing and spending than the other. The only period during the past fifty years in which the U.S. government had a budget surplus was 1998-2001 under President Bill Clinton and a Republican-controlled Congress.

Even when I state these facts, there are people who disagree with me. They don't agree that these are facts. Or they don't agree these facts are relevant.

Also, I sometimes read complaints that the wealthy are taxed too much. To make their argument, writers make statements like, “The top 50% of taxpayers pay 97% of all federal income taxes.” While this statement is true, I don't feel like it's a true measure of where tax burdens fall.

I believe there's a better, more accurate way to analyze tax burdens.

Effective Tax Burden

To me, what matters more than nominal tax dollars paid is each individual's effective tax burden.

Your effective tax burden is usually defined as your total tax paid as a percentage of your income. If you take every tax dollar you pay — federal income tax, state income tax, property tax, sales tax, and so on — then divide this total by how much you've earned, what is that percentage?

This morning, while curating links for Apex Money — my second personal-finance site, which is devoted to sharing top money stories from around the web — I found an interesting infographic from Visual Capitalist. (VC is a great site, by the way. Love it.) They've created a graphic that visualizes effective tax rates by state.

Here's a summary graph (not the main visualization):

State effective tax rates

As you can see, on average the top 1% of income earners in the U.S. have a state effective tax rate of 7.4%. The middle 60% of U.S. workers have a state effective tax rate of around 10%. And the bottom 20% of income earners (which Visual Capitalist incorrectly labels “poorest Americans” — wealth and income are not the same thing) have a state effective tax rate of 11.4%.

Tangent: This conflation of wealth with income continues to grate on my nerves. I'll grant that there's probably a correlation between the two, but they are not the same thing. For the past few years, I've had a low income. I'm in the bottom 20% of income earners. But I am not poor. I have a net worth of $1.5 million. And I know plenty of people — hey, brother! — with high incomes and low net worths.

It's important to note — and this caused me confusion, which meant I had to revise this article — that the Visual Capital numbers are for state and local taxes only. They don't include federal income taxes. (Coincidentally, I made a similar mistake a decade ago when writing about marginal tax rates. I had to make corrections to that article too. Sigh.)

GRS readers quickly helped me remedy my mistake, pointing to the nonprofit Tax Foundation's summary of federal income tax data. With a bit of detective work, I uncovered this graph of federal effective tax rates by income from the Peter G. Peterson Foundation. (Come on. What parent names their kid Peter Peterson? That's mean.)

Federal effective tax rates

Let's put this all together! According to the Institute on Taxation on Economic Policy, this graph represents total effective tax rates for folks of various income levels. Note that this graph is explicitly comparing projected numbers in 2018 for a) the existing tax laws (in blue) and b) the previous tax laws (in grey).

TOTAL effective tax rates in the U.S

Total Tax Burden vs. Total Income

Here's one final graph, also from the Institute on Taxation and Economic Policy. This is the graph that I personally find the most interesting. It compares the share of total taxes paid by each income group to their share of the country's total income.

Tax burden vs. total income

Collectively, the bottom 20% of income earners in the United States earned 3.5% of total income. They paid 1.9% of the total tax bill. The top 1% of income earners in the U.S. earned one-fifth of the nation's total personal income. They paid 22.9% of total taxes.

Is the U.S. tax system fair? Should people with high incomes pay more? Do they pay more than their fair share? Should low-income workers pay more? Are we talking about numbers that are so close together that it doesn't matter? I don't know and, truthfully, I don't care. I'm concerned with personal finance not politics. But I do care about facts. And civility.

The problem with discussions about taxation is that people talk about different things. When some folks argue, they're talking about marginal tax rates. Others are talking about effective tax rates. Still others are talking about actual, nominal numbers. When some people talk about wealth, they mean income. Others — correctly — mean net worth. It's all very confusing, even to smart people who mean well.

Final Note

Under the Digital Accountability and Transparency Act of 2014, the U.S. Department of the Treasury was required to establish a website — USASpending.gov — to provide the American public with info on how the federal government spends its money. While the usability of the site could use some work, it does provide a lot of information, and I'm sure it'll become one of my go-to tools when writing about taxes. (I intend to update a couple of my older articles this year.)

U.S. federal budget

The USA Spending site has a Data Lab that's currently in public beta-testing. This subsite provides even more ways to explore how the government spends your money. (I also found another simple budget-visualization tool from Brad Flyon at Learn Forever Learn.)

Okay, that's all I have for today. Let the bickering begin!

More about...Taxes

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Steve S
Steve S
4 months ago

I think whatever data you present or whatever point you are trying to make, you need to be explicit about what “taxes” you include in your data.

Do you count payroll taxes (social security and Medicare)? Do you include local sales and property taxes? Etc.

Both sides talk past each other because they include different datasets in their numerator or denominator and come up with percentages to fit their agenda.

Thanks for including links and explanations for where your numbers come from!

Marie Jacobs
Marie Jacobs
4 months ago
Reply to  Steve S

I agree that these types of specific details of exactly what is included as income and in taxes for these graphs are precisely what allows each author to spin the numbers to support any argument and make it hard for readers to agree on “the facts”. For example, is my 7-year-old kid included as a “poor person” on these graphs since she’s one of the large number of Americans that pay no federal income tax? She is sure paying state sales tax on most things she buys with her chore or birthday money but it isn’t subject to federal income… Read more »

Joe
Joe
4 months ago

Also, what do you count as income? Unrealized capital gain? Tax protected dividend in the retirement account? Capital gains in your trust fund?
Rich folks can hide their income from taxes a lot more effectively than regular people.

I suspect your graph above only counts taxable earned income.
The last time I looked, our effective tax rate was 12%. That’s pretty bad according to the chart. We’re getting screwed somehow. And that doesn’t even count property tax.

Yet Another PF Blog
Yet Another PF Blog
3 months ago
Reply to  Joe

This +1000. These charts always show tax rate on income (which necessarily excludes unrealized gains which encompass most of the increase for HNW individuals). Would be very interested in seeing similar charts on effective tax rate based on net worth or YoY net worth increase.

F. Oskar
F. Oskar
4 months ago

The Clinton years were unique. Reagan and his successor Bush had done the unthinkable, they won the cold war. Russia was down and out, China was laying the groundwork to become the threat it is today, but it wasn’t formidable back then. Every president since Clinton has had to deal with the Chinese and Russian military threat. This is likely to continue for decades. Clinton inherited the oval office at an opportune time.

KVA
KVA
4 months ago

Just as an FYI, you’d be wrong in your assumption of percentage of taxes to percentage of total income. The top 5% paid 58% of the taxes and received 35% of the income in 2018: https://taxfoundation.org/summary-latest-federal-income-tax-data-2018-update/

People could certainly argue good/bad on that. But as you said, facts are useful.

Julius Rosen
Julius Rosen
3 months ago
Reply to  J.D. Roth

Uhhh. In Florida I pay no income state tax.

Bryan
Bryan
4 months ago

JD, can you further support the statement that “low-income earners pay a larger share of their income to taxes than high-income earners do”? You embed the Visual Capitalist graph, but that article explicitly states that “Federal taxes are not considered.” The article even includes an editor’s note that federal taxes are progressive, not regressive. According to the CBO (as of 2014), federal taxes are much higher for top earners than low income earners. (https://www.washingtonpost.com/news/wonk/wp/2014/04/11/your-taxes-are-really-low-in-one-chart/). I can’t find an analysis of all taxes, but given that the vast majority of our taxes are federal, is your statement correct?

Bryan
Bryan
4 months ago
Reply to  J.D. Roth

Very much appreciate your willingness to address points like this. Love the blog. Keep up the good work.

Vano
Vano
4 months ago

I’m currently re-listening to my “Millionaire Next Door” audiobook. It’s revelations about how much of their total wealth the rich pay in income taxes bears repeating: Because they only realise a small fraction of their wealth as income the typical Millionaire only pays about 2% of their total wealth in income taxes each year. Compare this with UAWs who, because they realise most of their wealth in income, will typically hand over 17% of their net worth every year in income taxes. If you want to become rich then your chances of doing so are infinitely higher if you find… Read more »

JC Webber III
JC Webber III
4 months ago
Reply to  J.D. Roth

I believe he meant percentage wise, not in absolute dollars.

Jon
Jon
4 months ago

Yeah, the problem with government – a monopoly with “exclusive use of force” – is that people can vote for things (including politicians and bureaucrats) without regard to the consequences of their actions, i.e., they don’t have skin in the game. So, you get some people that are special interests that have a disproportionate advantage to show up in numbers and vote for their advantage over the other larger group of people who might not want said benefit. I’m not sure of a better system for governance but it seems when you have competed entities you get a more responsive,… Read more »

Jon
Jon
4 months ago
Reply to  Jon

Also, just because you are wealthy on paper, say a billionaire, you might not be truly that wealthy. Let’s say you are Jeff Bezos and you decide to sell all your assets at once. And let’s hypothetically say that much of that money is tied up in shares in Amazon. Amazon’s stock price would go down a lot trying to sell all of those shares at once. So he wouldn’t be able to get as much as he is worth on paper (that and if he were selling all his shares at once people might think there is something wrong… Read more »

El Nerdo
El Nerdo
4 months ago
Reply to  Jon

Alas, poor Jeff! I knew him, J.D., a fellow of limited wealth, of inferior fortune…

https://www.forbes.com/sites/angelauyeung/2019/07/31/jeff-bezos-sells-about-18-billion-worth-of-amazon-shares-in-three-days/

Jon
Jon
4 months ago
Reply to  El Nerdo

That’s awesome. It actually came true. Except that it wasn’t all of it – really a small portion. Which would have plummetted the stock if it were all of it. But do notice he can’t sell it off all at once, only piecemeal. And I should have probably used someone that wasn’t worth multi billion dollars worth of money. Also, notice that when he did get that money he still had a significant amount of that money taken away from him. So, you would need to slash that from his true net worth. Granted he is still fabulously wealthy –… Read more »

El Nerdo
El Nerdo
4 months ago
Reply to  Jon

Well, the sale wasn’t even a thing that registered until he reported it. 1.8 billion in 3 days. Not for personal luxuries but to fund his rocket company. Which is bound to make him more money. He only owns something like 17% of the company. So he alone wouldn’t tank the price. But if he really wanted to cash out he wouldn’t need to dump it into the market—he could arrange to sell privately to Berkshire Hathaway, or Alibaba, or some sovereign fund (but probably not his Saudi friends, lol). I don’t resent him, he runs a great business, I’m… Read more »

El Nerdo
El Nerdo
4 months ago
Reply to  Jon

Furthermore (I only realized this afterwards, sorry for the delay) his (relatively) small stake in Amazon still lets Bezos control the whole beast. After his divorce turns out he kept just 12%, but retained the voting rights of the shares he gave up. Amazon is an enormous company that is transforming the world economy at a much greater level than the personal wealth of its founder. So, while his “paper” wealth may account for his ownership, it doesn’t take into account the incredibly greater wealth and power it leverages. E.g., Warren Buffet may have donated a large portion of his… Read more »

Jon
Jon
4 months ago
Reply to  Jon

I agree money does afford people power and prestige that they might not otherwise get. But at least I can choose to not do business with them at little expense. Yes, I might still have some indirect interaction with that person/company. But I don’t have much of a choice when it comes to governments, they are hard to escape. I guess I could go “underground” and not participate in the economy and then not have to pay taxes which fund things that I disagree with, like unjust wars. But that is a huge “inconvenience” compared to not shopping on Amazon.… Read more »

Dan
Dan
4 months ago

I work with numbers for a living. The thing that bugs me these days as we’ve become a more “data driven” society is exactly what JD points out — when a person makes an argument, he picks definitions and data to suit his/her position. From a numbers standpoint, one thing that stacks the deck against people who are both low wealth and low income is that they probably have a negative net worth, which means they get non-sensical values when trying to compute tax rates as a function of wealth. Then there’s me, with a middle class income, where *all*… Read more »

BobJ
BobJ
4 months ago

I’m not a rich man by any means.. BUT, I think the rich pay their fair share. If it wasn’t for the rich the government would have a lot less money to spend. And their would be no incentive to become rich. J.D., how do you feel about the richest Americans (liberals) in New York, California and other liberal states complaining about having their mortgage interest deductions cut? LIberal are good at complaining until it affects them. How do you feel about heirs of farms having to sell the farm because the estate taxes are too high to keep the… Read more »

Rebecca
Rebecca
4 months ago
Reply to  BobJ

Just a note that you have it backwards about undocumented people and social security – they pay into social security but will never see any of that money, which will all go to American citizens/permanent residents.

Janette
Janette
4 months ago
Reply to  Rebecca

Some, some pay Social Security IF they have “borrowed” an identity. Many get paid sub standard wages and do not pay into the social structure. It stinks either way. They either pay in and get nothing in the end—or they don’t and get slave wages.

F.O.
F.O.
4 months ago
Reply to  Rebecca

Rebecca, The illegals working farms in my area, work under the table. They do not pay into SS, they do not pay taxes at all.

Angelica
Angelica
4 months ago
Reply to  F.O.

So if you got rid of all the “illegals,” would there be enough citizens to pick the crops?

Dorf
Dorf
4 months ago
Reply to  Angelica

And the farmers paying the ‘illegals’ under the table are also avoiding paying employer taxes. I can imagine the system seems to be working for them.

Paul
Paul
4 months ago
Reply to  BobJ

As a farm heir, my opinion is there is no more reason for farmers to get special treatment than any other assets, whether as an Investor or business only. Currently individuals can pass estates valued up to 11 million free from federal estate tax; couples over 22 million. Certainly only the largest farms have values higher, and should pay estate taxes accordingly.

BobJ
BobJ
4 months ago
Reply to  Paul

Local farms where I live are selling to big corporations.. and that’s not good for consumers.

Jersey Dave
Jersey Dave
4 months ago
Reply to  BobJ

In 2013 undocumented workers contributed $12 billion to Social Security; In 2016 they contributed $13 billion. Apparently, some of the undocumented workers paid in cash contribute through a legally obtained ITIN so they are in good standing should there be a future opportunity to apply for a green card or citizenship in the future.

https://www.marketplace.org/2019/01/28/undocumented-immigrants-quietly-pay-billions-social-security-and-receive-no/

zzzzzz
zzzzzz
4 months ago

I totally agree with you about the confusion/conflation a lot of people have between wealth and income. They are two different, but often related, concepts.

Perhaps that confusion is at the root of some peoples’ financial struggles.

Ben
Ben
4 months ago

This short video from VOX helps bridge the gap of how both parties are correct in their arguments.

https://youtu.be/kXCGbAv8YPw

Mr. P2F
Mr. P2F
4 months ago

Good post JD. You’re right about folks arguing over facts supported by different data points or even interpretation. Would be helpful to conversations to understand the data that supports your discussion rather than just accepting and repeating.

Luke
Luke
4 months ago

Thinking critically… would taxing all the undocumented immigrants working in the US today even compare to the potential revenue if: 1. corporations and the wealthiest citizens didn’t have low marginal tax rates (corporate and capital gains), or 2. didn’t have access to tremendous tax shelters and other accounting loopholes? Illegal immigration presents other challenges for the country and some of our citizens, but it shouldn’t be used as a scapegoat or to distract from discussion around far simpler and for more rewarding solutions. Current estate taxes, capital gains taxes, and property taxes vastly favor the wealthy. Not only are long-term… Read more »

Tim
Tim
4 months ago

It is a little unfortunate that the US tax system is so complex between state/local/federal taxes that it leads to this much confusion. There’s also a lot of opportunity for people to cherry-pick details of the tax code that support their preferred value judgement while ignoring the bigger picture.

I also think that people don’t realize how big the gap is in tax treatment between wage and business income. That hard to convey though with simple numbers or facts – it pretty quickly gets into technicalities and I understand most peoples’ eyes glazing over at that point.

Janette
Janette
3 months ago
Reply to  Tim

I will never forget the day I learned that my parents paid less tax then we did. they made 15x our wage, but it was all “in the company”. Hummmmmm.

Ditte
Ditte
3 months ago

As a Dane, I am used to 45% tax.

But then all is free, and we are paid to study.

I don’t envy you one bit. ?

S.G.
S.G.
3 months ago

This topic is definitely quite complex. Another layer of complexity is direct payments such as section 8, SNAP, medicaid, etc. Whether you think those are good or bad, I think they need to be acknowledged in discussions of taxes as the other end of the equation. Many taxes go to public services, but the goal of welfare policies is direct redistribution of resources from high income to low income individuals through taxation. I hate using the word “fair” because it has no solid meaning outside of a game. What is frustrating about these discussions is they need to start with… Read more »

Mid America Mom
Mid America Mom
3 months ago

Always a topic with friends – taxes! When thinking of moving somewhere in regards to our financial health, I, like many, look to the “best to” move lists but they never are great with the whole picture. So I dig into the numbers on many sites. Two you listed – the tax foundation and ITEP – are wonderful. And for our family medical is a concern so I also search for those costs as they, like all insurance, are determined by State. I even look at move calculators – cost of living comparisons. And more! It can be very involved… Read more »

Peter
Peter
3 months ago

“Come on. What parent names their kid Peter Peterson? That’s mean.”

I mean, that’s sort of a self-answering question. Clearly the answer is the kind of parent who is named Peter.

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