Making More Of The Income Of The Wealthiest Taxable
Policymakers can change the tax code in several ways to treat some or all of the unrealized capital gains of the wealthiest households as taxable income. One is to make the gains taxable each year, as Senate Finance Committee Chairman Ron Wyden and others have proposed by shifting to a so-called mark-to-market system for taxing capital gains.
President Biden proposes a more modest approach. He would leave deferral in place so that, each year, wealthy people with large unrealized capital gains would continue to pay no tax on the increase in their wealth while they are alive. Instead, Biden would require that the wealthiest people pay income taxes on this untaxed income from unrealized capital gains when they die. Specifically, his proposal would eliminate stepped-up basis at death for unrealized capital gains of more than $1 million for an individual or $2 million for a married couple .
By letting wealthy people avoid paying tax on their unrealized gains during their lifetime, the Biden proposal to tax these gains at death would still result in a lower effective tax rate than if the gains were taxed each year, just as wage earnings are taxed each year. The conservative Tax Foundation has noted the benefit of deferral to wealthy households, explaining in 2019 that deferral matters a great deal. This is because deferral allows a taxpayer to delay paying tax for years even while the asset appreciates and earns income.
Who Pays The Majority Of Taxes In This Country
screenwriter said:Then someone needs to tell them there is a way to willingly pay more to the government than the amount owed. There is also no obligation to claim any deductions on your taxes – which would also increase the amount due. So, this just doesn’t “add up” so to speak…
MrWonka said:Why would I pay more when my neighbor benefits equally? If my neighbor and I both make 100k, but I voluntarily choose to pay higher taxes to improve the roads he still gets to drive on them. If the benefit to us both is equal then the expense should be as well should it not?If all taxes were voluntary almost nobody would pay them and our country would fall apart.
Who Pays What On Tax Day
Its almost Tax Day and millions of Americans across the country are mumbling and grumbling as they write big fat checks payable to Uncle Sam. Attitudes about paying taxes are consistent. The majority of Americans say their taxes are too high and less than one in 10 say taxes are too low.
This should surprise no one. The federal tax code is a complex abomination that feeds into Americans anxiety over income security. People are generally uncertain about how much they owe from year to year and show strong cynicism about how the money is spent.
Further, more and more Americans believe they are being taxed unfairly. Americans will typically say that the poor pay very little in taxes and the rich are able to circumvent the system to avoid paying their fair share. As a result, grandstanding about the so-called middle-class squeeze is now commonplace among our elected officials.
So who exactly is paying all the taxes?
The truth is that the vast majority of federal income taxes are paid by high-income earners. According to the most recent IRS data available, the top 10 percent of households with incomes roughly $100,000 or greater pay roughly 70 percent of all federal income taxes. That share is up from just below 50 percent in 1980. If you include the top quarter of all taxpayers, the share balloons to 85 percent.
The growth of non-payers has been nothing short of remarkable.
If people are grumbling about the check the have to write now, just wait.
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The Tax Cuts And Jobs Act Reduced Average Tax Rates Across Income Groups
The 2019 filing season was the second filing season under the TCJA. The TCJA made many significant, but temporary, changes to the individual income tax code including lower tax rates, wider brackets, a larger standard deduction, and an expanded child tax credit. The net effect of all the changes was to lower tax burdens, on average, for taxpayers across all income levels.
In 2019, individual taxpayers paid $1.6 trillion in individual income taxes, $23 billion less than in 2017, even as adjusted gross income was $946 billion higher. Average tax rates were lower in 2019 than in 2017 across all income groups. Average rates for the bottom 50 percent fell from 4.05 percent in 2017 to 3.54 percent in 2019 and for the top 1 percent, from 26.76 percent to 25.57 percent.
The share of income taxes paid by the bottom 50 percent of taxpayers changed little from 2017, when it was 3.11 percent, to 3.06 percent in 2019. The share of income taxes paid by the top 1 percent increased slightly from 38.47 percent in 2017 to 38.77 percent in 2019.
Propublica Shows How Little The Wealthiest Pay In Taxes: Policymakers Should Respond Accordingly
With a recent blockbuster story by the investigative nonprofit ProPublica, and follow-up stories in leading TV and print media, it is clearer than ever that some of the nations wealthiest individuals pay little or no income tax each year. This growing recognition comes as policymakers need to raise substantial additional revenue to rebuild the nations decaying infrastructure and address glaring economic and racial inequities that COVID-19 and the deepest economic downturn since the Great Depression both highlighted and exacerbated. As they seek to raise more revenue, policymakers should look to increase taxes on the nations wealthiest households, which not only enjoy enormous tax breaks but also have done extremely well in recent decades while incomes for most others have risen much less.
These tax breaks, which policymakers have expanded in recent years, help to widen the enormous gaps in income and wealth between the nations richest people and everyone else. The top 1 percent of households in terms of income receive the vast majority of capital gains and a large chunk of dividend income, and they are reaping most of the benefits of a new deduction, enacted in the 2017 tax-cut law, for whats known as pass-through income, which the owners of partnerships and certain other businesses report on their individual tax returns.
To address these flaws in the tax code, the President and Congress should:
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The Drivers Of Tax Revenues
Rising GDP is associated with rising tax revenues
We have already pointed out that rich countries tend to collect much higher tax revenues than poor countries. The visualization provides further evidence of the extent of this correlation.
The vertical axis measures GDP per capita , while the horizontal axis measures tax revenues as share of GDP. The vertical axis is expressed by default in a logarithmic scale, so that the correlation is easier to appreciate you can change to a linear scale by clicking the Log button.
We can see that there is a strong positive correlation: richer countries tend to have higher tax revenues as a share of their GDP. And this is also true within world regions .
Early-industrialized countries became better at collecting revenue as they developed
We argued above that the efficiency of tax collection is a strong predictor of cross-country differences in tax revenues rich countries have more capacity to extract revenues. As historical data shows, this capacity was largely possible because, throughout the 19th century and up until the first half of the 20th century, these countries found increasingly cheaper ways to collect taxes.
Tax collection costs as a percentage of the amount collected by central governments, US and UK, 1787/96-2011 Figure 2 in Lindert 22
Tax collection relates to the strength of political institutions
Tax revenue vs constraints on executive authority
Sales And Excise Taxes
Sales and excise taxes are the most regressive element in most state and local tax systems. Sales taxes inevitably take a larger share of income from low- and middle-income families than from rich families because sales taxes are levied at a flat rate and spending as a share of income falls as income rises. Thus, while a flat rate general sales tax may appear on its face to be neither progressive nor regressive, that is not its practical impact. Unlike an income tax, which generally applies to most income, the sales tax applies only to spent income and exempts saved income. Since high earners are able to save a much larger share of their incomes than middle-income families and since the poor can rarely save at all the tax is inherently regressive.
The average states consumption tax structure is equivalent to an income tax with a 7.1 percent rate for the poor, a 4.8 percent rate for the middle class, and a 0.9 percent rate for the wealthiest taxpayers. Few policymakers would intentionally design an income tax that looks like this, but many have done so by relying heavily on consumption taxes as a revenue source.
On average, states rely more heavily on sales and excise taxes than any other tax source. Sales and excise taxes accounted for 35 percent of the state and local taxes collected in fiscal year 2015. However, states that rely much more heavily on consumption taxes increase the regressivity of their state and local tax systems:
FIGURE 9
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Federal Taxes Paid Per Capita
While the list of states paying the most total federal income taxes is dominated by high-population states, the picture changes somewhat when you look at it in terms of the average amount paid per person.
Though it has an adult population of just 575,000 and is not a state, the District of Columbia has one of the highest average income rates at $60,435 per adult resident. High average incomes tend to mean high tax burdens, which is why the District of Columbia tops the list of federal income taxes paid per adult.
Mississippi residents have the lowest average federal tax burden, at $2,883 per adult resident. However, this is nothing to celebrate because its due largely to also having the lowest average income.
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Undermining Progressivity With Tax Breaks For Wealthy Taxpayers
In contrast to states that improve tax fairness with tax credits for low-income families, more than a dozen states currently allow substantial tax breaks for the wealthy that undermine tax progressivity. Two of the most regressive state income tax loopholes are capital gains tax breaks and deductions for federal income taxes paid .
In combination with a flat rate structure, these tax breaks can create an odd and unfair situation where the highest income taxpayers devote a lower percentage of their income to income taxes than their middle-income neighbors.
For example, Alabama allows a deduction for federal income taxes. Although Alabamas income tax is essentially flat, the federal income tax is still progressive. So Alabamas deduction for federal income taxes disproportionately benefits the states wealthiest taxpayers. As a result, effective marginal income tax rates in Alabama actually decline at the states highest income levels. Despite the 5 percent top tax rate, the effective income tax rate on the very wealthiest taxpayers is actually less than 3 percent. Among the six states that allow a deduction for federal taxes, three allow a full deduction for federal taxes, including Alabama, while the other three have a partial deduction.
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Most Individual Taxes California $2345b
In total, California contributes the most individual taxes to the federal budget.
As of the most recent tax year for which figures were available , Californians paid over $234 billion in federal income taxes. Thats about 15% of the national total, and nearly 95 times as much as paid by residents of Vermont.
What About States Without Income Taxes
Not levying a personal income tax requires tradeoffs that are often detrimental to tax fairness. It is a common misconception that states without personal income taxes are low tax. In reality, to compensate for lack of income tax revenues these state governments often rely more heavily on sales and excise taxes that disproportionately impact lower-income families. As a result, while the nine states without broad-based personal income taxes are universally low tax for households earning large incomes, these states tend to be higher tax for the poor.
FIGURE 8
Note: The nine states without broad-based personal income taxes are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. Tennessee levies a limited personal income tax that only applies to interest and dividend income it is set to expire in 2021.
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The Effect Of Credits And Deductions
Tax credits and deductions must also be taken into consideration because they heavily influence how much of an individuals income will ultimately be taxed.
The taxpayer with the $300,000 income can bring that figure down by claiming the standard deduction.
For a single filer, the standard deduction is $12,550 for 2021 and $12,950 for tax year 2022.
So their taxable income would drop to $287,450 in 2021 and $287,050 in 2022 .
The $15,000-a-year persons taxable income would drop to just $2,450 in 2021, assuming theyre also single and they claim the $12,550 standard deduction, while their 2022 taxable income after a $12,950 deduction would be only $2,050.
The six-figure taxpayer might potentially bring their taxable income down even more by itemizing instead. According to the most recent IRS data available, Taxpayers claimed $190.1 billion in itemized charitable donation deductions in 2019. The taxpayer who earns just $15,000 a year likely would not contribute much to that number. The same applies to the mortgage interest deduction, which resulted in $185.0 billion being shaved off taxpayers incomes in 2019. Low-income individuals generally dont pay enough interest on mortgages to give them a sizable tax deduction. Property and state taxes accounted for $139.0 billion in claimed tax deductions in 2019, and it stands to reason that the majority of that total can be attributed to people who paid the most in such taxeshigh-income individuals.
Changes Expected In Next Years Study
Because it takes a while for the Internal Revenue Service to finish collecting taxes, reviewing returns and compiling data, information based on tax returns is generally a couple years old. That means there might be an especially big change in tax burdens in next years version of this study.
The Tax Reform Act was passed in late 2017, which means it first took effect for the 2018 tax year. We expect data for that year to be available in time for next years study.
While changes to the tax brackets made by that law will apply uniformly to people across the country, one change has impacted people in some states much more than others.
Capping the state and local tax deduction at $10,000 will be especially hard on taxpayers in states where:
- State income tax rates are high
- Local property taxes are high
- Average incomes are relatively high
While residents of some states will mostly benefit from the general lowering of tax rates that was part of the Tax Reform Act, the capping of the SALT deduction has likely caused others to owe more taxes.
States with the characteristics listed above are likely to climb higher on the lists for all categories of this study: total taxes paid, per capita taxes paid, percentage tax burden and increase over time.
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The Least Regressive State And Local Tax Systems
Ten jurisdictions with more equitable state and local tax systems can be found in Figure 5. Six of the ten California, the District of Columbia, Delaware, Minnesota, New Jersey, and Vermont had positive scores on ITEPs Tax Inequality Index, meaning that their state and local tax systems do not worsen income inequality. Thoughtful, progressive tax policy decisions permitted these six jurisdictions to make their tax systems somewhat more equitable for those with the least ability to pay taxes.
But none of these six tax systems are robustly progressive in a traditional sense. Rather than seeing effective tax rates steadily rise throughout the entire income distribution, some of these jurisdictions see peaks, where taxes on middle-income families are somewhat higher than at the top, or valleys, where low-income families face higher rates than the middle-class.
Several important factors define states with more equitable tax systems. Here is what they have in common:
FIGURE 5
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Low Taxes Or Just Regressive Taxes
This report identifies the most regressive state and local tax systems and the policy choices that drive that unfairness. Many of the most upside-down tax systems have another trait in common: they are frequently hailed as low-tax states, often with an emphasis on their lack of an income tax. But this raises the question: low tax for whom?
No-income-tax states like Washington, Texas, and Florida do, in fact, have average to low taxes overall. However, they are far from low-tax for poor families. In fact, these states disproportionate reliance on sales and excise taxes make their taxes among the highest in the entire nation on low-income families.
FIGURE 10
Figure 10 shows the 10 states that tax poor families the most. Washington State, which does not have an income tax, is the highest-tax state in the country for poor people. In fact, when all state and local taxes are tallied, Washingtons poor families pay 17.8 percent of their income in state and local taxes. Compare that to neighboring Idaho and Oregon, where the poor pay 9.2 percent and 10.1 percent, respectively, of their incomes in state and local taxes far less than in Washington.
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