America's tax code is more fair than people give it credit for

Everyone likes to complain about taxes. But America’s tax system is more fair than people on the right or the left tend to give it credit for — in part because of big changes under President Barack Obama.

When you look at all taxes combined, the breakdown of “who pays what” looks about like a lot of people say it should: Almost everybody pays something, and rich people pay a much higher share of their income than poor people.

The chart below is based on 2017 federal tax estimates from the Tax Policy Center, which employs alumni of Republican and Democratic administrations; and 2015 state and local tax estimates (the most recent available) from the liberal Institute on Taxation and Economic Policy:

Contrary to what you might hear, the chart shows that:

  • Almost everybody pays something. Taxpayers in the bottom fifth of the income distribution (average income: $US14,190) may not pay much federal income tax, but altogether they pay about 15% of their income in tax, with about two-thirds of that going to state and local governments.
  • The richest people tend to pay a substantially higher percentage of their income in taxes than middle-class or poor people do. The top 1% of taxpayers (average income: $US2,093,940) pay about 40% of their income in tax, in part because, as stockholders, they are the ultimate payers of much of the corporate income tax.

A lot of complaints about taxes being unfair come from looking at one part of the tax system in isolation.

Conservatives say too many Americans lack “skin in the game” because almost half of Americans pay no federal income tax. Liberals note that Social Security tax stops after $US127,200 in income, and that state and local taxes tend to be a bit regressive.

But when you add all the taxes together, they produce a distribution of the tax burden that makes a lot more sense than the distribution of the burden of any individual tax.

Thanks, Obama

You can thank Obama for making American taxes so progressive.

An under-discussed aspect of his legacy is significant tax increases on the wealthiest Americans — taking the top federal tax rate on salaries from 37.4% to 42.6%, and top tax rate on capital gains from 15% to 23.8%. Before those changes, which became effective in 2013, this chart would have looked a lot flatter at the top end.

Undoing these tax increases has been at the top of the Republican policy agenda — which is why the Republican “healthcare bill” was designed mostly as a vehicle to cut taxes on the rich, and pay for the tax cuts by cutting Medicaid. But so far, Republicans do not look poised to succeed at undoing this part of the Obama legacy.

There is room for improvement

American taxes are not perfect. For one thing, even though our taxes are progressive, there is a lot of room to debate whether they are progressive enough.

Our tax code also has significant problems with what is called “horizontal equity” — that is, taxpayers of similar means paying very different tax rates. Some rich people pay a lot more than 40% of their income in taxes; others can exploit tax preferences to pay a lot less.

Our corporate income tax (most of which is borne by owners of capital) also has significant fairness problems.

The US famously has one of the world’s highest business tax rates — 35% — and also famously has lots of exemptions that allow companies to pay, on average, only about half the official rate.

But the use of those exemptions is uneven. Companies in some sectors (like utilities and retail) have little ability to shield income from tax and tend to pay close to the full 35%. In other sectors (like pharmaceuticals and high-tech) it is common to get tax bills almost down to zero.

Levelling this playing field would make it possible to make the US tax system more progressive: It would be possible to get more tax revenue from companies (and therefore from wealthy stockholders) without raising taxes on those companies that already pay very high rates.

But overall, the system is already more fair than most people realise.

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