Are Americans Really Overtaxed?

William G. Gale
William G. Gale The Arjay and Frances Fearing Miller Chair in Federal Economic Policy, Senior Fellow - Economic Studies, Co-Director - Urban-Brookings Tax Policy Center

February 24, 1999

As President Clinton and congressional Republicans dicker about how to use the projected budget surpluses, a near constant drumbeat emanates from tax-cut advocates: Taxes are at record high levels and are imposing increasingly crushing burdens on American families.

The first claim is right: Federal, state and local taxes comprised just under a third of all income generated in 1998, the highest level ever. But the second claim is wrong. In fact, for the vast majority of families, taxes are as low or lower than they have been in the past 20 to 30 years. Overall tax payments have risen because the rich have gotten richer at an impressive rate and because they have faced higher tax rates due to policy changes in 1990 and 1993.

Tax-cut advocates like to report that the typical two-earner family paid nearly 40% of its income in taxes last year. This claim has acquired a life of its own, but it is flawed and vastly overstates tax burdens faced by most households.

The misleading estimate comes from a study by the Tax Foundation, a Washington organization that tracks tax policy. In fairness, the conceptual issues surrounding what is a “tax” or “income” and how to determine who bears the ultimate burden of taxes paid by businesses can be surprisingly complex and require judgment as well as rigor. But close inspection of the Tax Foundation’s study, by the Center on Budget and Policy Priorities and others, reveals several problems. The foundation’s tax measure does not include adjustments for popular deductions like child credits or flexible spending accounts. The measure of income overlooks pension contributions and health insurance. The study imputes some estate-tax liability to the typical two-earner household, even though only a tiny proportion—1.5%—of people who die face any estate tax liability. The foundation adds corporate taxes to families’ tax burdens but does not add corporate earnings to families’ income.

Other studies that avoid these flaws yield dramatically different conclusions about family tax burdens. A Treasury Department study, using a methodology that has not changed over the course of several administrations, shows that across a wide range of income levels, federal income taxes as a share of earnings are down. A four-person family with earnings of about $55,000 will pay 7.5% of that amount in federal income taxes in 1999, the lowest rate since 1966. For families with earnings half as large, the 1999 income tax rate is the lowest since 1955. Families with earnings of almost $110,000, who are in the top 10% of the income distribution, will pay a projected 1999 income tax burden of 14.1%, the lowest rate since 1972.

Adding Social Security and Medicare taxes to the Treasury income tax estimates raises the estimated tax burden, but does not change the conclusion that taxes are low relative to previous years. Congressional Budget Office estimates show that, for households in the bottom 60% of the income distribution, the burden of all federal taxes is at a 20-year low. Only among the top 20% of households did total federal taxes rise in the last 15 years, and only back to 1970s levels. The Joint Tax Committee estimates federal burdens that are even lower than CBO’s.

These studies suggest that a reasonable estimate is that all federal, state and local taxes account for about 26% to 30% of income for families in the middle fifth of the income distribution. This figure overstates the true tax burden, though, because about two-fifths of the total represents Social Security and Medicare contributions that entitle workers to future benefits. Many families pay substantially less: A family of four can earn more than $28,200, or about $540 per week, and pay no federal income taxes.

American tax burdens are also low compared with those in other industrialized countries—among the 20 largest in 1996, the U.S. had the lowest ratio of taxes to gross domestic product.

Ultimately, whether Americans are overtaxed is a judgment call. The measure of appropriate tax levels depends on many factors, including an analysis of how the money is used. But the evidence speaks clearly in at least two dimensions: The vast majority of American families pay nowhere near 40% of income in taxes, and they forfeit a smaller share of their income to taxes today than they would have in the past with the same income. Advocates might have other reasons to urge a cut in tax rates, but the debate over their plans should begin with facts rather than fantasy.