Will Income and Social Security Taxes Go Up Or Down In The Future? A Look Back

Everybody says up, right? While I can’t predict the future, I thought it would be interesting to see what the historical tax rates were for different income groups. Here is some data taken from the Congressional Budget Office about historical federal tax rates as a percentage of “comprehensive household income”, defined as pretax cash income plus income from other sources like rental income and dividends. Note that this isn’t the same as your marginal income tax rate, which is the tax rate on your last dollar earned; This is a percentage of all your income.

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As a reference, here are the quintiles for annual household income as defined by the US Census Bureau in 2005:

1st Quintile: $0 – $18,500
2nd Quintile: $18,500 – $34,738
3rd Quintile: $34,738 – $55,331 (Median: $46,326)
4th Quintile: $55,331 – $88,030
5th Quintile: Over $88,030

Looking at the chart, it seems that the top quintile has paid about the same amount overall, while the overall effective federal income tax rate has actually fallen for the rest.

Now, what about social insurance payroll taxes that go towards Social Security and Medicare? These have been going up over time for just about everybody:

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I even added a linear trendline, which although completely unscientific, suggests that if such a trend continues the effective percentage will increase approximately 1% every 20 years.

Comments

  1. I’m assuming the top graph is only federal income tax and not inclusive of social security? Given that social security is a regressive tax (given the annual cap) I would expect that would also have significant impact on the 2nd graph if were broken into icome quintiles.

  2. Wow, actual data, this is good research Jonathan.

    It’s interesting to note how taxes for the “rich” went up over the last decades whilst taxes for the “poor” actually went down. Really worth noting that -5% on the bottom quintile, which effectively means that the “marginalized” portion of society is actually receiving extra dollars from the great big pool of tax dollars.

    Not only are they not paying any taxes they’re actually supplementing with tax dollars. Moreover the second quintile just reached 0% there, which again makes you wonder.

    It almost seems like all of the tax dollars are coming from the top 60% of households with the top 20% likely bearing the tax burden for the bottom 40% (and maybe then some).

    Those are some pretty important numbers!

  3. Yes, income tax and payroll taxes are separate in the graphs above. The CBO link does have a total effective tax ratio as well, but I like separating the two out.

    I also find it interesting to see that there is a Robin Hood thing going on here. There are so many reasons behind this decision that I can’t even pretend to understand them all.

  4. Interesting definition of income “pretax cash income plus income from other sources like rental income and dividends”. That works for most ordinary folks, but take the guys who are taking their private equity public. Their income is considered capital gains and would not be included in this definition. Back before Regan started to lower the marginal rates they were up at 80-90%. Yes, 80–90%. So people didn’t get paid the tremendous salaries that they now get. However, it doesn’t mean that they weren’t compensated.

  5. Interesting, although to truly get a good feeling for this we need to look at the concentration of wealth as well the share of the tax burden and marginal tax rates. If you had a graph showing the pre-tax income of different segments of the population as well as the current extremely low marginal tax rate, you would notice that while the effective rate for the top earners is pretty flat, the pre-tax income of these same people (top 1%) has risen dramatically (share of tax burden then obviously increases as well although not nearly as much). This means that the extremely rich are making a lot more money and not having to pay the marginal tax rates that historically have been much higher. So for all those that say the extremely well-to-do are getting the shaft that is not the case. The people that are really eating it are those of us making b/w $195,000-$500,000+/- as we are truly the ones paying the higher tax rates on that graph. Those who used to pay the 40%+ highest tax rates on millions of their income are now only at 35%. While I obviously like 35 more than 40 I think it could be stiffer for the super rich, maybe another bracket for those over $1,000,000 (as it has been in the past).

    Just one of these $10,000,000/yr folks would have to pay $450,000 more in taxes at just 40% At some of the more historically common rates of 50% they would be paying millions more. Maybe then we could lower some of the other bracket thresholds or tax rates. We have an increasing gap b/w the richest 1% and everyone else. Adjusting the taxes may help to mitigate that.

  6. Hey, you guys making 80k/year or more, if you dont like paying higher taxes move to another country or SHUT UP!

    and if you find the same job that pays that much in another country, im happy for you, have a good time :)

  7. All you people holding Roths out there I would take your tax break now if you can either through your 401k or a traditional IRA. Just think in 20 years when the social secuirity and health care problem explodes where is the governent going to look for more revenue? They are going to look at taxing Roth distributions–think about it–it would soak the wealthy and there are more people needing social security and health care than a tax break on their Roth–politicians don’t want to vote for this but their backs are going to be against the wall so in the end it would be an easy vote for them because fixing social security outweighs your tax break on your Roth–it is coming be afraid be very afraid.

  8. The authority on tax rates and income distribution is Emmanuel Saez, a professor at Berkeley. All of his papers, and his data can be downloaded from his website.
    http://elsa.berkeley.edu/~saez/

    Suffice it to say that effective tax rates for the top incomes have plummetted since WWII, while their share of all income has risen dramatically.

  9. Also, the negative 5% for the bottom quintile is due to the Earned Income Tax Credit. If your EITC is larger than what you pay in federal income tax, you receive back the difference. For example, if we were to take the “typical” person in this quintile and assume that they made $12,000 (just a guess), they would receive back (again, typically) $600 more than they paid in federal income tax.

  10. Joe, I disagree… If anything, we should be putting money in Roths now because tax rates will never be lower. No way will the government be able to tax Roths in the future. They will be able to legally raise other tax rates, print more money, reduce social security benefits, raise the retirement age, etc. but they can’t touch my Roth money! If they try, I would seriously consider not paying taxes at that point. I’ll be a feisty old man by then anyway.

  11. There’s an alternative explanation for the behavior of the income tax curves: The income gap between the rich and poor grew wider. This explains why higest quintile stayed about the same with all tax cuts and new tax laws, while other curves dropped.

  12. Gates VP – in regards to the taxes on the rich, rather than look over the entire graph of 25 years, look at the parts. In the early Reagan years, the top quintile showed a sharp drop, with a leveling in later years and through Bush I. The Clinton years shows a steady increase, while there is another sharp drop starting with Bush II.

    As for the 5th quintile, while the income tax rates have dropped, indeed went negative, that group has always paid more in Social Security taxes, which as seen in the second graph have been steadily increasing.

    As I’m sure you are aware, the negative tax rate for that group (and likely the 4th quintile, also) is largely due to the Earned Income tax credit, which is refundable. The working poor with kids, in other words.

    Joe – I think it’s going to be hard to change the taxable nature of the Roth. They may very well do away with the Roth and allow no further contributions, but much harder to change the rules after the fact.

  13. Actually ttfitz, I’m Canadian so EI tax credit means something totally different to me :) So I’m not really aware, though my experience with the system here is relatively similar. Anecdotally, it seems like the bottom 40% of Canadian society are definitely paying more than 0% total federal tax, though universal healthcare does have a role to play there.

    BTW, Rick, isn’t it simple statistics that the top 1% are constantly and disproportionately earning more & more? If the middle of your distribution curve is higher, then don’t the values for your sigmas become exponentially higher? So doesn’t this mean that special taxes or no special taxes that the gap between the top 1% and everyone else will always be widening faster and faster.

  14. I think it would be interesting to see a true total trend. Specifically, the graph starts a couple years before one of the biggest (and best lol) tax bills was passed.

    I am curious what would occur if the graph started around WWII time when the top 1% had a marginal rate of approx 75%?

    Additionally, Jonathon – do these numbers account for simple inflation?

    Just a few thoughts….

  15. Why is everyone so concerned with the income gap? If someone with $10Mil puts his money in a 5% CD, he’s still going to make more (every year) than most of us, unless you make a special 90% tax bracket for him. And if you do that, see how long he keeps his money in the country. Getting rich is the carrot that keeps alot of us working, investing, innovating. Take that away and see how long we last…

  16. Heather says:

    Sales taxes and fees are not indexed to income. And I’m not sure that income tax is the major tax paid by the super-rich. I’d love to see the same graph that incorporates more forms of government revenue.

  17. Yeah, folks have hinted at this but not said it: average tax rates in retirement do not matter — marginal ones do. It matters for all of the decisions you make: to keep working or to retire fully, open a Roth, whatever. Marginal rates (the tax rate on the last dollar of income) are what is important. Average rates were quite high until 1986 (despite the Reagan tax cuts), but the many deductions ensured that the average tax rate was quite low. My thinking is that rates will probably creep up. The biggest “tax expenditures” (untaxed portions of personal income) are for housing interest, health care and for charitable contributions. These are sacroscant, even if taxing them could reduce rates. And Roth IRAs will likely be a good deal.

  18. Ted Valentine says:

    The reason for the “Robin Hood” thing is because (generally) the people in the top quintile make their money on the backs of the people in the bottom quintile.

    Also, I really dislike separating the taxes. Its not accurate to the bottom line. Furthermore the payroll taxes should account for the “employer” cost. If you add all that in, you will see that the poor are paying more than their fair share.

  19. The group that is really getting hosed is the group making a little more than 100K and writing off aggressive tax shelters like property taxes and state income taxes and kids. Those elite earners get slammed with AMT and lose those nasty tax shelters.

  20. Heather – follow the link Jonathan provided to the Congressional Budget Office report and you will find a spreadsheet with a table showing what is labelled “Total Effective Federal Tax Rate”, which tries to show “effective tax rates for the four largest sources of federal revenues–individual income taxes, corporate income taxes, payroll taxes, and excise taxes–as well as the total effective rate for the four taxes combined.”

    In searching the site, I found there is additional data for two more years, 2003 and 2004, but there didn’t appear to be a webpage for that report, only a PDF. For those interested, the PDF is available at http://www.cbo.gov/ftpdoc.cfm?.....038;type=1.

    That report will show that the steep drop in effective income tax rates for the top quintile continued over the next two years, while it tended to level out for the others.

  21. Ted- Since a quintile is 20%, and as of 2005, only approximately 7% of households have over $1Million dollars (excluding primary residence), that leaves twice as many people with less than that who acquired it with hard work and savings…probably including you at some point in your life. Or would you like to redefine your comment to include only those who make _more_ than you? The only thing easier than spending someone elses money, is justifying it…

  22. ttfitz- thanks for doing the legwork to identify the additional data, however I have to disagree with your conclusion. I see that ALL quintiles “level out” between 2003 and 2004. However if one compares 2002-2004, only the bottom quintile’s effective tax rate levels out at 4.5-4.6. The rest of them continue to go down between 0.6 and 1.5 points, however the top quintile is not the largest drop. Here are the 2001-2004 effect rates side by side:

    2001 2002 2003 2004
    Lowest Quintile 5.2 4.6 4.6 4.5
    Second Quintile 11.5 10.8 9.8 10.0
    Third Quintile 15.1 14.4 13.8 13.9
    Fourth Quintile 19.2 18.7 17.4 17.2
    Highest Quintile 26.7 26.1 25.0 25.1

  23. Mike – you are looking at the total taxation table, not the income tax table that Jonathan used for his graph. Further, you have for some reason started with 2001 rather than 2000, which would be the starting point to look at the effects of the Bush cuts.

    Using the income tax figures Jonathan started us out on, from 2000 to 2004, the drops were, from lowest quintile to highest, 1.6, 2.3, 2.1, 2.2, and 3.6. And let’s keep in mind what those are percentages of – average income for the lowest quintile was $15,500 in 2000 vs $205,000 for the highest. So that’s around 250 bucks savings for the poorest folks, and almost $7500 for the richest.

    Speaking as someone well into that top quintile, I find that appalling. Nobody likes to pay taxes, and I certainly take every tax break given me, but with the kind of deficits this country is running, this is just wrong.

  24. Maury–The number of people needing a social security/health care fix will far outweigh the number of people who have Roths. Tax ideas are like water they will flow to the path of least resistence and that will be the Roth holders because they are outnumbered, they will be sitting on a huge amount of dollars and will have at least the benefit of tax deferred growth–that is how this will be sold to the public and guess what the public won’t care as long as social security and health care are fixed. Do you think a politician is going to be concerned about the Roth voting bloc or the social security voting bloc–they will say you had tax deferred growth over the last 40 years we need to tax someone sorry it has to be you but there are not enough Roth voters to throw me out of office.

  25. ttfitz- Please do not confuse my interpretation of the numbers as an endorsement of a piece of legislation, the current administration, and/or deficit spending. I was simply pointing out that when you consider the total tax picture, the conclusion that you drew when viewing the additional 2003 and 2004 data with regards to the top quintile is misleading. The top 20% may have figured out how to lower their income taxes, but their overall tax rate trend is still consistent with the other quartiles.

  26. Clicking here will give you Saez’s data from 1913 to 2005.

    http://elsa.berkeley.edu/~saez/TabFig2005prel.xls

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