How Progressive Is The US Tax System?

incometaxBy George Noga


Are Social Security and Medicare Taxes Regressive? Surprise!

One of the biggest issues during the recent election campaign was that the “rich” in America do not pay their fair share; hence, a substantial tax increase is needed to achieve fairness.

This post examines that question in our usual fact-based and principled manner assisted by my CPA and tax professional background. Fairness is inherently subjective; nevertheless, there are many objective metrics available. Comparisons to other countries and to changes over time are good places to begin.

USA Compared to Other Countries and Over Time

Let’s begin by looking at those who pay no income taxes. We often hear 47% of Americans pay little or no income taxes. That is correct insofar as it goes, but it does not present the most accurate picture.

When tax credits (such as EITC) are included, the bottom 60% pay less than 1% of all income tax. As recently as a few decades ago the comparable figure was between 20% and 30%. This leads to the first 2 of 10 facts about the progressivity of US taxes.

1. No other nation has near 60% not paying taxes; the US is the least regressive on earth.

2. Recently the share not paying taxes more than doubled making us far more progressive.

Compared to other countries the story is the same. Studies by the OECD (and many others) show the US with the most progressive tax system in the world based on the relative shares of income and income taxes paid. For example, the top 10% of incomes in the US pays 35% more of the total tax burden than in Sweden for crying out loud and 22% more than in France.

The conclusions are similar for the top 1%, 5% or any other income cohort measured. Moreover, the OECD study includes federal, state and local taxes and also social insurance taxes – about which I have much more to report infra. The OECD study also shows that over the past 30 years the US has grown much more progressive relative to Sweden, Germany, Finland, et. al. This leads to the next three facts about the progressivity of the US tax system.

3. Any way measured, US taxes are the world’s most progressive – and by a large margin.

4. The US has become much more progressive both over time and relative to other nations.

5. Corporate rates in America (35%) also are the world’s highest, 60% higher than Sweden.

Capital Gain and Dividend Tax Rates

Obama wants to raise tax rates on both capital gains and dividends as an issue of fairness;  often citing Warren Buffet and Mitt Romney as paying low capital gains rates. Although many advanced countries do not tax capital gains at all, the current US rate of 15% is low both comparatively and historically.

In my post about Buffet (it would be the same for Romney) I demonstrated how his overall tax rate really is 60% over the entire life-cycle and that the dividend and capital gains taxes are only 2  of 5 levels of taxation in the full cycle – the other 3 being income, corporate and estate. Capital gains also taxes phantom income resulting from inflation – which, as astute economists, we all know is really just another form of taxation.

Even for class warfare, it is counterproductive to raise taxes on capital and dividends. Capital formation makes workers more productive and raises their wages more-so than the returns to capital. High tax rates are a double whammy; they shrink the capital available for risk taking by taxing it away before it is accumulated, and then the limited capital that does come available is discouraged from starting new enterprises. Following are a few more facts to add.

6. Taxation over the complete cycle is 60%, not the 15% for only the cap gain portion.

7. Raising taxes on dividends and capital gains harms the economy and average workers.

Okay, But Aren’t Payroll Taxes Steeply Regressive?

Whenever I discuss the progressivity of income taxes, the  instantaneous knee-jerk response from liberals is immediately to blurt out something like, “Yes, income taxes may be progressive but payroll taxes are steeply regressive and this makes the overall tax system regressive.”

No lesser luminaries than Paul Krugman and Robert Reich have succumbed to this error – probably disingenuously, i.e. on purpose. They fail to make the necessary distinction between a tax for general purposes and one that is linked to a specific benefit to a specific taxpayer.

Regarding Social Security, one must consider three factors. First, although the tax base is capped, so is the benefit. Second, higher income workers receive less of a benefit as a percentage of their contributions than do lower income workers. Third, Social Security is subject (85%) to the highly progressive income tax. Objective independent studies, including one by the Social Security Administration, conclude Social Security is modestly progressive.

In the case of Medicare there is no cap on income for the taxes paid in and the benefits should be the same for each beneficiary. However, lower income beneficiaries consume more benefits and academic peer-reviewed studies (Stanford and USC) found that the poorest cohorts receive the most benefits at any age. This leads to some additional facts.

8. Social Security is modestly progressive lifetime per a 2009 study by Social Security.

9. Medicare is an extraordinarily progressive public program per the Stanford/USC studies.

10. Per CBO 2012, the entire tax system including cap gains and payroll taxes is progressive.

John Adams famously said: “Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passion, they cannot alter the state of facts and evidence.” Mindless repetition about folks not paying their fair share and liberals desperately clinging to the belief payroll taxes are progressive do not make either of these assertions true.

“The US has the most progressive tax system in the world by a large margin and it has been getting ever more progressive for decades.”

The facts and evidence demonstrate beyond room for doubt that the US has the most progressive tax system in the world – and by a very wide and expanding margin. Not only that, but it has gotten much more progressive in recent years. Moreover, there is something terribly wrong with 60% of the people paying no tax in the richest country in the history of the planet.

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