You’re not paying the tax rate you think you are

By David Cay Johnston
February 21, 2012

If you make more than about $33,500 a year, your federal income tax burden is probably lighter than you think.

The portion of your income that you pay in taxes is your “effective tax rate.” But when politicians and pundits talk about effective tax rates, the data they typically use relies on an incomplete measure for income. Use an incomplete measure for income and your tax rate calculation comes out high.

In a new analysis the Tax Policy Center, a nonpartisan Washington research organization, used a wider measure of income to calculate effective tax rates. The rates are much lower using this broader measure of income.

The Tax Policy Center computer model of the tax system, which estimates how changes in the law would affect tax burdens, has repeatedly made projections that subsequent events showed were accurate. The center is a joint project of two Washington research organizations, the Urban Institute and the Brookings Institution. The George W. Bush administration went out of its way to praise the reliability of the center findings even when they were not helpful to administration policy.

The incomplete measure is called “adjusted gross income,” or AGI. This is the number on the last line of the front page of the standard tax return.

To get a fuller picture, the Tax Policy Center used what it called “cash income” to calculate effective tax rates. This included municipal bond interest, government benefits and many of the other items that are excluded from AGI. Use this fuller measure of income and the share of income that goes to taxes falls.

SIGNIFICANT VARIATIONS

In its new analysis, the Tax Policy Center found that the discrepancy between these two ways of measuring tax rates varies significantly between different income groups.

For the middle fifth of taxpayers, those with cash income between $33,542 and $59,486 a year, the average tax burden is 4.1 percent of adjusted gross income but only 3.2 percent of cash income. So these middle-income people are paying almost one percentage point less of their income in federal income taxes than they might imagine based on the popular debate.

One percentage point may seem small, but for people in this income group it means they are actually paying one fifth less in income tax than they might think.

The percentage point discrepancy widens as incomes increase. For the next fifth of taxpayers, those earning between $59,486 and $103,465, the average federal income tax is 8.2 percent of AGI but only 7 percent of cash income, a difference of 1.2 percentage points. For the top fifth, those earning more than $103,465, the average federal income tax is 17.3 percent of AGI but only 14.9 percent of cash income.

For the top tenth of one percent – whose combined income comes close to equaling that of the bottom 50 percent of taxpayers – the disparity is even greater. The tax rate is 23.6 percent of AGI but only 19.8 percent of cash income, a difference of 3.8 percentage points.

UNDERSTATED DISPARITY

As valuable as the Tax Policy Center’s report is, the center acknowledges that it understates the disparity for people at the very top. The reason for this is that the computer model cannot capture certain kinds of income that are only available to the very wealthy. For example, Congress considers the personal use of corporate jets to be income. But, under rules Congress set in 1985, only a small fraction of the real value is included in AGI. Unfortunately, the Tax Policy Center’s model does not capture the remainder as part of cash income.

For the 40 percent of Americans on the bottom of the income ladder, using AGI to measure income also distorts the effective tax rate calculation, but in a different way.

On average, people in the bottom 40 percent receive money from the federal income tax system rather than pay money into it, so their effective tax rates are negative.

This is because the first $19,000 of income for a couple was free of income tax last year. At the same time, they may have received cash payments such as the Earned Income Tax Credit for the working poor or the Child Tax Credit for parents of children. These tax credits are not included in AGI, but the Tax Policy Center counts them as cash income.

The payments the poorest fifth of taxpayers – those who made less than $16,812 last year – get on average from the tax system amount to 12.3 percent of their AGI. But, when calculated against cash income, these payments amount to only 5.8 percent. So, the AGI method overstates the amount this group is getting from the tax system.

For most of us – those in the middle class and above – our effective tax rate is lower than politicians say. So smile a bit today. The cost of civilization is not as high as you’ve been told.

15 comments

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When I am told I am being paid $50,000. and then am handed $30,000. it is difficult to understand how I can be paying 3% “tax”. It looks much more like 40%, but then I never was much good at political mathematics. Perhaps one of the many taxes I pay is 3%?

The fact is that fraud is so common in the USA that it is wilder than the wildest days of the old “Wild West”. There are simply no consequences for deliberately taking by deception. Except for “little people”.

Like “weapons of mass destruction” “tax” is a mighty difficult thing to define.

Posted by txgadfly | Report as abusive

@ txgadfly, the figures in my column are clearly identified as averages. An individual taxpayer will have a different experience than, say, a family of four, all of which are blended in this data.

If you are single, working with wages as your only source of income, take the standard deduction and are under 65 then in 2011 you should have paid on $50,000 gross in FIT of $6,256 (or 12.5%), plus a deduction for the (reduced) SS and Medicare taxes of $2,825.

Assuming a state income tax of 3% more ($1,500), your total income, payroll and state income tax would be $10,851 (or 21.7% of $50,000) leaving you more than $39,000, far more than you say in your post. Even unemployment and disability (state) deductions would change this only slightly.

If you took home $30,000 net pay then look at what your employer deducts for health care, what you save for retirement. Those, of course, are not taxes but an untaxed benefit (healthcare) and savings.

There is nothing deceptive about these numbers or the ones in my column. It not possible for federal income and payroll taxes, even when state income taxes are added, to take 40 percent of your paycheck at the $50,000 level even if you are single and take the standard deduction, which means you pay the highest possible rates.

Posted by DavidCayJ | Report as abusive

“On average, people in the bottom 40 percent receive money from the federal income tax system rather than pay money into it, so their effective tax rates are negative.”

What an infuriating statistic.

Posted by CapitalismSays | Report as abusive

bullspit – this guy is ignorant.
your effective tax rate and mine includes property tax, sales tax, motor vehicle tax plus state and local and school tax and is way above the rates quoted by the IRS.

Posted by 1234pjw1234 | Report as abusive

@CapitalismSays: The income tax entry threshold is incredibly low. The paragraph after the one you quoted gives an example — your income would have to be less than $19k per person of a married couple. For an unmarried person with no children, the threshold below which you pay no taxes is even lower. This is the same, whether you were born, work, and live in San Diego, Detroit, or Memphis. The average income for these areas differ as do the costs of rent (most people in the bottom two income quintiles do not and cannot own) and other living expenses. Childcare costs also fluctuate regionally, whereas tax credits for having children do not.

(This chart from the organization which created the report to which this article refers shows the threshold over time: http://www.taxpolicycenter.org/taxfacts/ displayafact.cfm?Docid=470)

Don’t be so quick to be infuriated by the fact that some assistance goes to the poor. Among the developed countries in the world, the United States provides near the least — be comforted. One argument that has been proffered against increased spending on social services (and tax credits for the poor) is that economic disparity is an engine which drives economic mobility. That argument, at least according to one recent study by the Economic Mobility Project, is unsupported. According to that study, the U.S. has the least economic mobility of almost any developed country in the world. It also is among those with greatest income disparity and highest poverty rates.

The fairly consistent association of low mobility and high disparity/poverty with low social spending should suggest that this is also not a simple question of agency in the “land of opportunity”. Though there are examples of individuals who have transcended their “class,” this is not representative. By and large, if your parents are poor in this country, you will be too. That suggests that the “land of opportunity,” and the “American dream,” are currently mythical as they are unsupported by recent statistics. That should be infuriating.

One motivation for those who are in the top quintile to reduce income disparity is that it (along with poverty generally) is positively associated with crime rates, including violent crime. Therefore, reducing disparity and poverty may very well reduce crime.

Posted by dtierney | Report as abusive

@CapitalismSays

Let’s be realistic, how are you going to squeeze any more out of people making $9/hour? They may not pay income tax but I assure you, unless mathematics has changed since I last checked, that a much larger percentage of their income goes to taxes on gas, food, clothing, utilities, etc. Should they receive money from the tax system? No, but ‘broadening the base’ will do nothing but bankrupt the millions who are already barely scraping by.

Posted by bitbyt | Report as abusive

Let’s see how much we are getting taken for a ride?
Mandatory expenses of being an American

Sales tax- 10 pct
State income tax 3pct
Fed tax 15 pct
Health and dental 3600 a year ( cheap)
Car registration 500 per year
Property tax 1200 per year

In the end you are paying well over fifty percent of your income to uphold a government that frankly doesn’t give a damn about you, is patronizing and stagnant.
I am thinking about jumping the border to retire in Mexico

Posted by Teddyrux | Report as abusive

Two people making 9$/hour, working 40 hours/week with two weeks unpaid vacation make $36,000/year. That’s above the bottom 40% of households. They’d be paying taxes. I’ll just leave it at that.

Its amazing what you can learn with Google and a calculator.

Posted by CapitalismSays | Report as abusive

And how many retail employees get 40 hours a week? Hospitality? Food service? The average workweek for non-supervisory non-farm employees in the private sector is 33.8 hours. How much should these people be paying and how much of an impact on the deficit would it make? And what does it do to clear up corruption, the very heart of the problem? If you want to be condescending you should back your voice up with some meaningful statistics. Google would be a good place to start.

Posted by bitbyt | Report as abusive

It’s easy to simply everything that all the debate is about today. Make the Tax Code plain at whatever level is “enough” (and what does that mean?) tax to run the government and eliminate thousands of pages of exceptions aexclusions, yada, yada… Start with this: Congress you take a 10% cut in pay and benefits, then to every “I MEAN EVERY” department of government cut your expenses next year by 10%. Then raise retirement age to 75…why is it still 65?? All this sound too simple? I think it comes close to balancing the budget and we all participate. I’m for that.

Posted by WouldChuk | Report as abusive

I believe we’re having a bit of a misunderstanding. At no point have I mentioned taxing the poor to solve the deficit problem. As you have mentioned, it won’t do any good (aside from being morally detestable). My point is that having 40% of our population dependent on government assistance is unhealthy for both an economy and a society. Instead of fixing the deep structural problems that have caused this, the government has opted to just redistribute income via the tax code. All that does is perpetuate the cycle and breed resentment on both sides of the equation. Apparently that’s the best we can do. I find that infuriating.

Posted by CapitalismSays | Report as abusive

The fact is that you are totally being ripped off. When you include sales tax, luxury tax, and inflation tax, you are being fleeced for half your money. Even with raises the real income has declined over the past 30+ years. There is no law mandating an unconstitutional income taxw. The reason you pay income tax is to pay the privately oned federal reserve interest that is owed by the technically insolvent US government. You should not be paying any income tax just like before 1913. Watch the documentary Freedom to Fascism. Wake up before you are left penniless.

Posted by zhanz | Report as abusive

If you’re not producing children, you’re doing it wrong. What I find infuriating is that we non-breeders get the real short end of the stick. I will post some of my real numbers up here but I think everyone knows what I’m talking about. Especially on the earned income credit. Also many “job creators” these days hire people on a contract basis which is yet another ripoff.

Posted by getbach | Report as abusive

we have to ask, At what point does this country stop running trillion-dollar deficits? When are we going to understand that now is a good time to become fiscally responsible? We have lived off our children and grandchildren long enough. It’s time to turn things around.

We’ve shifted from a culture of celebrating and encouraging those who are productive and hardworking, to a culture where handouts, bailouts, freebies and entitlements dominate. Why am I paying the freight for those who have been reckless and irresponsible, whether it’s on Wall Street or in Washington or anywhere else in the community? I think we’re becoming a very different nation.”

Posted by buckaroo5 | Report as abusive

Greatly appreciate your work DCJ; especially – Free Lunch: How the Wealthiest Americans Enrich Themselves at Government Expense (and Stick You With the Bill). The problem is that most people in the US who don’t benefit from our current system either refuse to accept this as fact, don’t have time to stop working minimum wage jobs to read up on the issue, or can’t connect the dots because of the subpar education so many US citizens receive. The best example of this is when a recent push to tax the very wealthy in the state of Washington was voted down. This wasn’t surprising given the lobbying against it. What was surprising was the language coming out of blue collar workers who were so upset about the wealthiest paying more in taxes to bridge the funding gap needed to support education – health care – police/fire service – etc. Faced with this, how can there ever be hope that things will change???

Posted by ProfMagyar | Report as abusive