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Businessweek Archives

Taxes: Lower Than You Think

Economic Trends


Federal rates are down sharply

How onerous is the federal income tax system as it applies to individuals? At first glance, the answer seems to be: very onerous indeed. Total personal tax payments as a share of household income have surged recently, for example. And despite seven revisions since 1980, the tax code is still replete with complexities and preferences that tend to encourage behavior that undermines economic efficiency.

This impression can be misleading, however. For one thing, the recent jump in receipts reflects growing prosperity--not high rates. Indeed, much of the increase has come from people cashing in gains on their stock holdings, even as the capital-gains tax rate has declined.

As for tax preferences, they have to be considered in light of declines in marginal rates. Such rates, which are the rates paid by taxpayers on incremental income, can have a potent effect on behavior. Other things being equal, the lower they are, the more likely people are to work, save, and invest--and the less likely they are to try to evade taxes through preferences or other strategies. Thus, low marginal rates are a key feature of an efficient tax system.

In a new study, economists Leonard E. Burman of the Urban Institute, William G. Gale of the Brookings Institution, and David Weiner of the Congressional Budget Office use survey and tax-filing data to estimate just how much the tax reforms since 1980 have lowered marginal rates actually paid by taxpayers. They find that two reforms have had the most impact: the 1981 Reagan cuts, which slashed all marginal rates and indexed brackets for inflation; and the 1986 act, which created two basic rates--of 15% and 28%. By contrast, the 1990 and 1993 revisions raised the marginal rate for just 1% of taxpayers.

For the vast majority of taxpayers, the study shows, declines in marginal rates have been dramatic (chart). Between 1980 and 1995, the share of taxpayers facing rates of more than 15% plummeted from 77% to 23%. And those facing rates of 28% or less rose from 77% to 96% of filers.

Meanwhile, the top income tax rate fell from 70% to 39.6%. And by 1995, that rate applied to fewer than 1% of taxpayers. (The main effect of the 1997 revision, which isn't covered by the study, was to cut taxes for those eligible for education and child-care credits, but to raise marginal rates for this group as the credits are phased out at higher income levels.)

These results need some qualification. The study focuses on marginal rates, not the total tax burden borne by households. Thus it doesn't count the impact of payroll taxes, which rose from a combined employer-employee rate of 12.26% to 15.3% during this period. Also, as the results show, the taxation of Social Security benefits that began in 1984 raised marginal income-tax rates by several percentage points for a minority of beneficiaries.

But even with these effects, says Brookings' Gale, "it's clear that most taxpayers today face far lower marginal rates than they did two decades ago."BY GENE KORETZReturn to top

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Service funds rise as cash aid falls

When reform of the federal welfare system was passed several years ago--putting a lid on federal grants but giving states more leeway on spending--some pessimists predicted it would touch off a "race to the bottom" by states eager to cut back aid to recipients. Instead, as a survey by the National Governors' Assn. indicates, spending is being reallocated to help lift citizens to self-sufficiency.

Between fiscal 1996 and 1998, reports the NGA, as welfare caseloads around the nation fell by 27%, state spending on support services per person rose sharply. While direct cash payments to recipients declined about as much as caseloads, outlays for work activities--from education and skills training to job placement and subsidized employment--rose by a third. And state spending on child care grew by an impressive 55%.

In many cases, states are doing more than reallocating funds once used for cash assistance. Massachusetts, for example, has upped support for child care, beyond the funds freed up by declining caseloads. In Minnesota, spending for child care has nearly doubled since 1996, and families with incomes below 75% of the state median level are now eligible for child-care subsidies.BY GENE KORETZReturn to top

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