American Puzzle: Income Rich, Revenue Poor

Listen to Republicans long enough, and you might believe we’re burdened with taxes like no one else. And many Democrats buy into this story too. But it is a well documented fact that the U.S. is one of the least taxed nations in the advanced industrial world. To deal with Medicare, the need for revenue is unavoidable. The same is true for Social Security. Proposals limited to cutting taxes and government spending are just not credible. And cutting government spending does not create jobs—it creates lay-offs.

But are we really a low-tax nation? Yes, we are, according to the Organization for Economic Cooperation and Development. The OECD Tax Database publishes a table of “Total Tax Revenues as a Percentage of GDP” for each of its member nations (Figure 1). These include most European nations, plus Canada and the U.S., Ireland and the U.K., Japan and South Korea, Australia and New Zealand, Mexico and Chile. “Total tax revenues” means all taxes: taxes on goods and services, on property, on incomes and profits, and taxes for social benefit programs.

Tax revenues as percent of GDP
Figure 1

In 2008, the latest year of full data, the U.S. ranked 31st out of 34 in total tax revenues as a percentage of GDP. The OECD average is 34.8%. The U.S. figure is 26.1%. The difference (8.7% of GDP) works out to $1.3 trillion. And that’s just for 2008.

But let’s think small for a moment. Payroll taxes––taxes for Social Security and Medicare––are relatively modest taxes. But they are also regressive, the same tax rate for everyone regardless of their ability to pay. And for Social Security, taxable income is capped currently at $106,800. The income cap makes the Social Security tax even more regressive.

To see this more clearly, consider the history of U.S. incomes between 1980 and 2008. The Census Bureau reports a rise during this period in the percentage of families with annual, inflation-adjusted money incomes of $100,000 and over, a rise from 13.2% to 26.0%. That’s almost double the 1980 percentage (Figure 2):

Family income distribution
Figure 2

Most of the action in Figure 2 is literally off the chart. A rising number of annual wage incomes in the last several years range from $100,000 on up to millions, hundreds of millions––and even billions for some hedge fund managers. Clearly, the center of gravity of income distribution has shifted markedly higher. Consequently, from 1980 to 2008, an increasing portion of wages, salaries, and bonuses has escaped Social Security taxes. Eliminating the cap on taxable income would capture the missing revenue and fix Social Security for the foreseeable future.

Fixing Medicare is a lot harder because costs keep rising faster than inflation. But a credible first step, together with the cost control measures of the Affordable Care Act, would be to make the payroll tax for Medicare progressive. The Medicare tax rate is 2.9%, split evenly between employers and employees at 1.45% apiece. Taxable income is not capped, but since the tax rate is 1.45% for everyone, it is a regressive tax. A moderately progressive tax on all incomes with steps, say, from 1% to 3%, would make a serious dent in future deficits due to baby-boomer retirements.

Census Bureau statistics don’t break out levels of income above $100,000. But recent work on U.S. income inequality by Thomas Piketty and Emmanuel Saez documents the higher levels. The top 10% of families in 2008 took home 35% of all wages, which includes bonuses and exercised stock options. In 2008 there were 15.2 million families in the top 10%. Collectively, they received $3.6 trillion dollars in pre-tax wage income, or an average of $234,717 per family. If they had paid 1% more in Medicare payroll tax, that would have added $36 billion to the Medicare trust fund––almost exactly the net drain of trust fund assets in 2010, as reported earlier this month.

Here’s how the top 10% has fared during the last 80 years (Emmanuel Saez maintains an updated Excel file at his website):

Top 10% wage income share
Figure 3

We are still the richest nation on earth, but we pay a painfully low percentage in taxes. Income rich, revenue poor. The oncoming crisis in social support programs demands action, and a modest turn toward progressivity in payroll taxes would make a big difference. The number of Americans lacking health insurance has topped 50 million (16% of the population), while private health insurers have had record profits for the last three years and still push for higher premiums. Certainly, as a nation of citizens, not just consumers, we can do better.


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