Declining Progressivity in US Taxes

by Linda Beale

Maybe at this juncture, when Congress is beginning to talk about what to do about the sunsetting Bush tax provisions, it’s an appropriate time to remind ourselves about our historic commitment to progressivity in our tax system. A good source for thinking about this is an article by Tom Piketty and Emmanuel Saez, How Progressive is the U.S. Federal Tax System? A Historical and International Perspective, 21 J. Econ. Perspectives 3 (2007).

What they show by looking at income and taxes over the period from 1960 to 2004 is revealing. While our system remains progressive to some extent, the progressivity has declined significantly. This is primarily, they say, because of the cuts in the corporate tax and the estate tax–taxes that impact the very wealthiest more than others because of their high ownership of financial assets. Our concept of distributive justice has always demanded that we should determine the tax burden based on individuals’ relative abilities to pay–that means that those with lots more should pay proportionately more of their income, since those with very little need all of their income just to meet daily needs, and those with considerable wealth won’t even notice whether they have another few dollars or not.

The decades since Reagan took office have taken a huge toll on that sense of shared commitment. Fueled by a religious-like belief in the mathematically elegant but unrealistic assumptions of the “free market” economists from the Chicago School (see Yves Smith’s book, Econned, for a good take-down of the freshwater economists), the GOP in Congress passed huge tax cuts for the wealthy accompanied by increasingly heavy payroll taxes for others at the same time that spending continued apace–in fact, Reagan, Bush1 and Bush2 all greatly increased the military budgets and the Bushes embarked on wars of choice that imposed significant budgetary demands. The wealthy have fought for laws that favor them–deregulation, zero capital gains taxation, lower corporate taxes, the ability to offshore businesses and assets freely, privatization of social security and other programs (that would put more dollars under direct control of investment bankers and insurers), and lowering of individual tax rates and provisions that phased out deductions for the wealthy (like the phase out of the itemized deduction, which was repealed under Bush, etc.).

There are some really great graphs in the article–so look at it rather than just reading these excerpts. But if you only have time for excerpts, here are some key ideas.

Progressivity of the overall tax code has unambiguously declined in the United States and in the United Kingdom. The average share of income paid by those at the very top of the income distribution has dropped substantially. Id. at 21

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Large reductions in tax progressivity since the 1960s took place primarily during two periods: the Reagan presidency in the 1980s and the Bush administration in the early 2000s. The only significant increase in tax progressivity since 1960 took place in the early 1990s during the first Clinton administration. Id. at 23

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many of the recent tax provisions that are currently hotly debated in Congress, such as whether there should be a permanent reduction in tax rates for capital gains and dividends, or whether the estate tax should be repealed, affect primarily the top percentile of the distribution—or even just an upper slice of the top percentile. This pattern strongly suggests that, in contrast to the standard political economy model, the progressivity of the current tax system is not being shaped by the self-interest of the median voter .12 Id. at 23.

12 Permanent reductions in dividend and capital gains combined with a repeal in the estate tax would certainly reduce the current progressivity of federal taxes and favor large wealth holders. The Alternative Mininum Tax, which is not indexed for inflation and hits more and more tax filers, will mostly increase tax burdens on the upper middle class but will not affect much the top 0.1 percent.

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The federal individual income tax is the largest tax, typically collecting 7–10 percent of GDP in most years since the 1960s. Individual income taxes declined sharply from 2000 to 2004 following the tax cuts of the Bush administration, falling from 10.3 percent of GDP in 2000 to 7.0 percent of GDP in 2004. The payroll tax financing Social Security and Medicare has increased significantly, climbing from about 2 percent of GDP in the 1960s to 6.4 percent of GDP by 2004. The corporate income tax has shrunk dramatically: it was typically 3.5– 4.0 percent of GDP in the 1960s, but had fallen to 1.6 percent of GDP by 2004. The estate and gift tax has always been very small relative to the other taxes, although it is important for distributional analysis because it disproportionately affects those with higher incomes. The estate tax collected about 0.6 percent of GDP in the 1960s, and 0.25 percent of GDP in 2004.

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The greater progressivity of federal taxes in 1960, in contrast to 2004, stems from the corporate income tax and the estate tax. The corporate tax collected about 6.5 percent of total personal income in 1960 and only around 2.5 percent of total income today. [emphasis added] Because capital income is very concentrated, it generated a substantial burden on top income groups. The estate tax has also decreased from 0.8 percent of total personal income in 1960 to about 0.35 percent of total income today. As a result, the burden of the estate tax relative to income has declined very sharply since 1960 in the top income groups.

[Hat tip to fellow Angry Bear rdan for reminding me about this article.]

crossposted at ataxingmatter