Taxes

Why It's So Hard to Cut the Middle Class's Income Taxes

They just don't pay as much. Meanwhile, the rich are earning more than ever.

Something always gets bigger.

Photographer: Daniel Acker/Bloomberg

Over the weekend, Trump administration officials hit the airwaves to argue that the tax cuts they're proposing will be great for the middle class. “It is our objective that the entire middle class does get a tax cut,” Treasury Secretary Steve Mnuchin said on ABC’s “This Week.”

Mnuchin and his colleagues were responding in part to an Urban-Brookings Tax Policy Center analysis of the plan released Friday. It found that while a great majority of middle-class Americans would see their taxes go down next year if the tax cuts outlined last week by the administration and Republican congressional leaders were to become law, the gains would be modest for most, a minority would see tax hikes, and more than 50 percent of the gains from the tax plan would go to those in the top 1 percent of the income distribution. Ten years into the new tax regime, the benefits would be even smaller for most Americans, with those from the 80th to 95th percentiles actually seeing their taxes go up on average, while the share of the gains going to the top 1 percent would be almost 80 percent. 1

Who Gains From the Trump Tax Plan

Estimated change in after-tax income, by income percentile

Source: Urban-Brookings Tax Policy Center

These are all estimates based on what at this point is still quite a vague proposal. They also don't factor in any increase in economic growth caused by the tax changes being contemplated, although experience indicates that any such increase would probably be modest. 2

What the estimates do reflect, though, is a simple reality: It's hard to cut federal income taxes on the middle class by all that much because the middle class -- unless you define it so broadly as to include some of those in the top 10 percent of the income distribution -- doesn't pay a lot of federal income taxes. Here is a breakdown on who paid the taxes in 2014, the most recent year for which the Internal Revenue Service has released data: 3

Who Pays the Income Taxes

Income and federal income taxes paid, by income percentile, 2014

Source: Internal Revenue Service

Or, to simplify:

Who Pays the Income Taxes, Short Version

Income and federal income taxes paid, by income percentile, 2014

Source: U.S. Internal Revenue Service

This reality -- that 70 percent of income taxes are paid by the highest-income 10 percent of taxpayers (as well as 83 percent by the top 20 percent, and 90 percent by the top 30 percent) -- has been trotted out from time to time in recent years as evidence that something has gone terribly wrong with the U.S. tax code. As former White House press secretary Ari Fleischer put it in a Wall Street Journal op-ed in 2009:

A very small number of taxpayers -- the 10% of the country that makes more than $92,400 a year -- pay 72.4% of the nation's income taxes. They're the tip of the triangle that's supporting virtually everyone and everything. Their burden keeps getting heavier.

That last part is a profound misreading of the evidence. The main reason the top 10 percent and top 1 percent are paying a higher share of income taxes than they did a few decades ago is not because their tax rates have gone up but because they're earning a higher share of income (and I'm sorry for not being consistent about the income percentiles I use to slice things up, but I am at the mercy of my data sources, in this case the Congressional Budget Office):

Whose Incomes Went Up Most

Cumulative pre-tax income change since 1979, by income percentile

Source: Congressional Budget Office

Still, it is true that those in the highest income groups have seen less of a decline in average tax rates since 1979 than the rest of Americans:

Whose Tax Rates Have Dropped Most

Average federal tax rate,* by before-tax income percentile

Source: Congressional Budget Office

*Includes payroll and other taxes.

When it went into effect in 1913, the federal income tax was targeted exclusively at the very affluent -- just 358,000 people (out of a population of 97 million) even had to file tax returns that year. It was only during World War II that the income tax became something that most American households had to reckon with. In recent decades, changes in both the income distribution and the tax code have shifted the income tax back somewhat in the direction of targeting mainly the affluent.

I don't happen to see anything wrong with that. Middle-income and low-income Americans pay lots of other taxes, including federal payroll taxes for Social Security and Medicare (which are accounted for in the last of the above charts, but not the others), and an array of state and local taxes that sometimes burden those with low incomes more heavily than the wealthy. They also indirectly bear some portion of the corporate tax burden, although there's lots of debate about how big that share is.

This does mean, though, that if you cut federal income taxes, you now have to work awfully hard to keep most of the benefits from flowing to the affluent Americans who pay most of those taxes. By targeting the state and local tax deduction and other, as-yet-unspecified deductions, the new tax framework does seem to strive to keep those in the 80th to 95th income percentile from reaping much of a windfall. But if the Urban-Brookings analysis is right, it bestows a huge windfall upon those with even higher incomes. If Congress wants to put significantly more money into the hands of the middle class instead, it would probably have to cut payroll taxes, make increased use of income tax credits (as opposed to tax deductions, which mainly benefit higher-income taxpayers), or simply appropriate more money. Cutting income taxes just isn't going to do it.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

  1. The household income cutoffs for this chart (in inflation-adjusted 2017 dollars) are, for 2018: 20 percent, $25,000; 40 percent, $48,600; 60 percent, $86,100; 80 percent, $149,400; 90 percent, $216,800; 95 percent, $307,900; 99 percent, $732,800. For 2027: 20 percent, $28,100; 40 percent, $54,700; 60 percent, $93,200; 80 percent, $154,900; 90 percent, $225,400; 95 percent, $304,600; 99 percent, $912,100.

  2. I realize that I'm giving such arguments awfully short shrift here, and that there is a chance that changes in the corporate tax code in particular could have positive effects on investment and employment in the U.S. But the predictions that administration officials and members of Congress have been making of growth effects so massive that they wipe out the cost of the tax cuts are ludicrous, and should be discounted.

  3. In this case the adjusted gross income cutoffs are (in 2014 dollars): 50 percent, $38,173; 80 percent, $90,606; 90 percent, $133,445; 95 percent, $188,996; 99 percent, $465,626; 99.9 percent, $2.1 million.

To contact the author of this story:
Justin Fox at justinfox@bloomberg.net

To contact the editor responsible for this story:
Brooke Sample at bsample1@bloomberg.net

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