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In preparation for a Senate Finance Committee hearing on “Fairness in Taxation” on Tuesday morning, the Joint Committee on Taxation (JCT) issued a report diving into the distributional impact of the federal tax system. Unfortunately, this report leaves out a lot of crucial context for its numbers, which will likely allow advocates of tax cuts for the rich to spin the numbers to make the tax system sound significantly more progressive than it actually is. Here are some important points to keep in mind:
1. The overall tax system is just barely progressive.
First, it is critical for lawmakers not to just look at the federal tax system in isolation, as the JCT report does, but at the tax system as a whole. While the federal tax system is generally progressive, state and local taxes are notoriously regressive. In fact, a recent report by the Institute on Taxation and Economic Policy found that the poorest 20 percent of taxpayers pay about twice the state and local tax rate of the top 1 percent.
A study of the overall tax system in 2014 (including federal, state and local taxes) by Citizens for Tax Justice (CTJ) found that our tax system is just barely progressive overall. For example, the richest taxpayers are paying tax rates very close to the rates paid by middle class Americans, with the middle 20 percent of taxpayers paying a 25.2 percent rate and the top 1 percent paying 29 percent on average. In addition, each income group’s share of total taxes paid closely mirrors their share of total income, with the top 1 percent paying 23.7 percent of all taxes while earning 21.6 percent of all income.
2. The tax system is not getting any fairer.
Opponents of raising taxes on the rich will likely point to the tables in the JCT report showing that the share of income taxes paid by the top 20 percent of households has gone up significantly in recent years, from 55.4 to 68.7 percent in 2011 to argue that taxes on the rich are at historic highs and should not be increased further. What this argument misses is that the portion of taxes paid by the rich have grown largely due to the increasing share of national income earned by the wealthy, rather than any increase in the progressivity of the tax system itself.
Providing insight on this issue, the JCT report shows that the progressivity of the federal tax system in 2011, as measured by the Reynolds-Smolensky index, is at precisely the same level as it was in 1980. Because income inequality has grown since 1980, this means that the federal tax system is having less of an impact that it once did in reducing income inequality overall. In fact, the federal tax system only reduced income inequality (as measured by the Gini Index) by 8 percent in 2011, in contrast to 9.5 percent in 1980. If anything, lawmakers should increase the progressivity of the tax system so that it can further reduce income inequality, rather than letting its positive impact stagnant or even decrease.
3. Wealthy investors pay a lower tax rate than other members of the top 20 percent.
One final point to keep in mind when discussing fairness in the tax code is that the preferential rate on capital gains and dividends allows many in the top 20 percent of taxpayers to pay a lower tax rate than the middle class. In its overall look at the distribution of the tax system, the JCT found that in 2011 the middle 20 percent of taxpayers paid a total federal tax rate of 11.2 percent, while the top 20 percent paid an overall tax rate of 23.4 percent. This comparison could be used to create the impression that all wealthy individuals are in fact paying their fair share, but grouping all of the top 20 percent together ignores the fact that they may pay significantly different tax rates depending on what percentage of their income comes from investment income, and thus is subject to a preferential rate compared to wage income.
When you break out those wealthy individuals, like Warren Buffett, who earn a significant amount of income from capital gains or dividends, the tax system ends up looking a lot more regressive. For example, in 2011, a taxpayer making between $60-65,000 would pay an average effective tax rate of 21.3 percent, yet a taxpayer making more than $10 million primarily through investments would have only paid an average effective tax rate of 15.3 percent. To make the tax system truly progressive, lawmakers should end the preferential tax rate for investment and tax it like wage income.