Tax and the CBO

Posted: Jun 07, 2001 12:00 AM
Late last month, the Congressional Budget Office issued a new study of effective tax rates by income. Soon thereafter, a liberal group called the Center on Budget and Policy Priorities put out a 13-page summary of the CBO report, highlighting everything in it supporting the idea that the rich are getting richer at the expense of everyone else. The clear implication of the CBPP spin on the CBO data is that tax cuts for the rich have somehow contributed to widening income inequality. But a deeper reading of the full 154-page CBO study shows that in fact the rich are shouldering a heavier and heavier burden of total taxation. Moreover, the study clearly shows that raising taxes on the rich, which the CBPP supports, would have no impact on reducing inequality. The fact is that the effective federal tax rate (taxes as a share of income) has fallen for every income group over the last 20 years EXCEPT those with upper incomes. For those in the bottom quintile (20 percent of the population), the tax burden has fallen from 8.3 percent in 1981 to 5.3 percent this year. Those in the middle quintile saw a drop from 21.9 percent to 20 percent. The other quintiles also saw a decline, except those in the top quintile, who saw an increase in their tax rate from 27.1 percent to 27.4 percent. Among those at the top of the income distribution, those at the very top saw the largest increase in their taxes. Those in the top 5 percent, who paid 24.9 percent of their income to the federal government in 1985, now pay 30.5 percent. As a consequence, those in the top 5 percent in terms of income now pay 39.4 percent of all federal taxes, up from just 28.5 percent in 1985. It is important to remember, too, that those in the top 5 percent of the income distribution may not really be "rich." The CBPP report emphasizes the average income of households in this category, which is an impressive $355,800. However, the income cutoff to get into the top 5 percent is just $93,300. In most large cities, this is a policeman married to a teacher's joint income. They probably don't realize that when liberals talk about "the rich," they mean them. The CBO report also notes some other important points about income distribution that seldom show up in liberal analyses. Following are a few. -- Families, individuals or households? It matters that when dividing the population up into quintiles or percentiles, one is dividing households, people or families. If one took the top 20 percent of people, for example, it would be a very different universe from the top 20 percent of families or households. Thus, the top 20 percent of the population in terms of people only has 18 percent of the households. The result is that many measures of income, such as the Census Bureau's, understate the amount of income going to those at the bottom, a fact grudgingly admitted by the CBPP in a footnote. -- What is income? Taxes are paid on a legally defined measure of income. But most income distribution analyses are based on a much broader measure. The CBO, for example, includes many non-taxable income sources in its definition of income, such as fringe benefits and contributions to pension plans. This tends to inflate incomes above what people think of as their "income." It means that many more people are "rich" than think they are. -- Incidence of taxes. Many liberal analyses of tax burdens exclude some taxes paid primarily by the rich, such as the corporate tax, while imputing to annual incomes the estate tax, which is paid only at death, out of assets, not income. This is why the cut in estate taxes makes the recently passed tax bill appear to tilt so much to the rich in liberal distributional tables. The CBO, quite rightly, excludes this tax from its analysis, on the grounds that it doesn't know whether decedents or heirs actually pay the tax. -- Mobility. Finally, liberal analyses imply that it is the same people in each income division every year. But in fact, there is substantial movement among and between income quintiles. The CBO reports that in any one year 12.5 percent of people will move up at least 1 quintile and 12.5 percent will move down. The CBPP dismisses this point by saying that mobility is not increasing and is therefore of no importance. But the existence of any mobility makes most liberal attacks on inequality effectively meaningless. It wouldn't be necessary to go through this, except that many reporters relied on the CBPP summary of the CBO study, rather than reading the original study themselves. Those who want to can find it on the Internet at, or they can call (202) 226-2809 and get a copy. *** Chart data: Shares of the Top 5 Percent, 2001 (percent) Total Income Taxes ---- 53.8 Total Federal Taxes* ---- 39.4 Pretax Income ---- 28.8 Aftertax Income ---- 25.8 Population ---- 5.0 * Including payroll and other federal taxes. Source: Congressional Budget Office