How much tax is too much

Bruce Bartlett
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Posted: Apr 11, 2006 12:04 AM

Last week, the Tax Foundation released new polling data on Americans' attitudes toward taxation. As always, it is interesting reading.

The most intriguing question to me is this one: "What is the maximum percentage of a person's income that should go to taxes -- that is, all taxes, state, federal and local?"

The question is ambiguous because it is not clear whether people are being asked about the effective rate of taxation (taxes as a share of income) or the marginal rate of taxation (that which applies to the last dollar earned). But either way, taxes are much higher than people think they should be.

According to the poll, 24 percent of people think all taxes should take less than 10 percent of a person's income. Another 43 percent think they should take less than 20 percent. And an additional 22 percent of people think the tax burden should be no more than 30 percent of income.

In other words, two-thirds of Americans think that 19 percent is the most anyone should pay, and 90 percent think that a tax rate of 29 percent should be the maximum.

How does this stack up against actual tax burdens? One way to look at it is to take taxes at all levels of government as a share of the gross domestic product -- the nation's total income. In 2005, taxes came to a little over $3.5 trillion and GDP was close to $12.5 trillion, for an effective tax rate of 28.5 percent.

Another way is to look at the Tax Foundation's "Tax Freedom Day," which calculates the day each year when we stop working for government and start working for ourselves. In effect, this measures taxes as a share of aggregate income. Last year, taxes took 29.1 percent of income by this measure, down from a recent high of 33.6 percent in 2000.

In short, the tax burden is well above the level that at least two-thirds of Americans think should be the maximum and right at the level that 90 percent of them believe should be the absolute limit.

If one thinks in terms of marginal rates, then taxes for many people are much, much higher than the vast majority of Americans think is appropriate. Looking just at the federal income tax, the top rate of taxation is 35 percent, which applies to taxable income over $336,550 (single and married). Those making more than $154,800 ($188,450 for married couples) must pay 33 percent on each additional dollar. The 28 percent bracket begins at $74,200 ($123,700 for couples), and the 25 percent bracket starts at an income of just $30,650 ($61,300 for couples).

Thus we see that marginal rates even for those with relatively modest incomes are well above what most Americans think should be the maximum.

Although the median family, which had an income of $54,061 in 2004, would probably be in the 15 percent federal income tax bracket, all of its earned income would also be subject to the Social Security payroll tax, which is 15.3 percent on all wages up to $94,200. Although, only half this tax is withheld from workers' paychecks, economists believe that they in effect pay the employer's share also, in the form of lower wages.

A single person earning between $74,200 and $94,200 is going to pay the 28 percent federal income tax on that income plus another 15.3 percent for Social Security as well, making his marginal rate more than 43 percent.

But then there are state income taxes in the vast majority of states. According to the Federation of Tax Administrators, in many of them the income at which the top rate kicks in is quite low. In California, the top rate of 9.3 percent starts at an income of just $41,447. So on the next $53,723 of his income, a single person in that state will be paying more than 50 percent in taxes.

Of course, it goes without saying that taxes will affect different people differently, depending on such things as whether they have children, whether they own a house or rent, how much of their income comes from wages or "unearned" sources like interest and dividends, and the extent to which they make use of tax saving opportunities such as putting money away for retirement.
 
The bottom line is that people are paying a lot of taxes even if they have incomes putting them squarely in the middle class. Little wonder, then, that three-fifths of people think their federal income taxes are too high in the Tax Foundation poll.

Unfortunately, taxes are going up regardless of what people think because of the vast government spending in the pipeline due to the aging of society. In the end, I think people will accept higher taxes rather than cut spending enough to prevent that necessity.