Over the past two decades, the U.S. individual income tax code has undergone some significant changes. It turns out that all of this hasn’t been what you might expect: federal income tax rates have fallen for every income group since 2001, with those with the highest incomes seeing the smallest declines (on a percentage basis at least) and those earning in the 50th to 60th percentiles the greatest reductions.
Internal Revenue Service numbers are released late every year with nearly two years, so the most recent numbers are from 2019. As you may know, the agencies picked the percentile groups, although it’s really the IRS that reports by top 50%, top 40%, etc., so to get the discrete slices you will have to subtract and divide.
One can observe an interesting feature of the federal income tax by looking at the very fine slices at the top of the income distribution. There is quite a progressive aspect to it in that higher incomes are taxed more heavily. In reverse, the top 0.1%, with the very highest earners paying a smaller share of their income compared to those made in the bottom share of the population. We’re talking about federal income taxes only.
According to Washingtonpost, Thomas Piketty and Emanuel Saez used a 2007 study to find that every income lower than the 90th percentile paid out more in Social Security and Medicare taxes than in federal income taxes, which led to a less progressive system of taxes overall.
Most, if not all, of the progressivity that remains in most of the country, is offset by regressive state and local taxes. Saez and Gabriel Zucman included health insurance premiums in their tax calculations “because it’s mandatory and reduces wages,” putting taxpayers in the 50th to 90th percentiles in a much worse financial situation than those above and below them.
The story of that is for another day! For the top 10% of taxpayers, the federal income tax matters most, and it is interesting to see how income tax rates have changed over the past two decades. Since the beginning, rates haven’t changed much:
Nevertheless, big things happened between the top 1% and the bottom 99%. The following is the progress from 2001 to 2007, by which time most of the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 and Jobs and Growth Tax Relief Reconciliation Act of 2003 had been fully implemented.
All income groups were taxed at a lower rate under the 2001 tax law. These cuts were accelerated by the 2003 tax law, which also reduced capital gains and dividend tax rates. Those in the top 0.1% receive the majority of their income from long-term capital gains as well, with two-thirds of the nation’s long-term capital gains going to the top 1% in 2019.
The income tax has long been regressive at the very top of the income distribution, due to the fact that long-term gains are taxed at lower rates than ordinary income. As a result of the 2003 legislation, 0.01% of taxpayers faced a lower tax rate afterward than those in the 97th to 98th percentile.
However, this effect is much less pronounced when there are few capital gains to be realized. Because incomes were lower for everyone else that year, tax rates fell for everyone else, but the top 1%’s rates rose because they were more dependent on ordinary income than usual.
Tax-rate curves were almost identical in 2007 and 2012 as a result of this temporary effect. Tax cuts from 2001 and 2003 were mostly temporary too, as a result of the strange (and, frankly, bad) way that laws have to be written to qualify as “reconciliation” legislation that does not require 60 votes to pass the United States Senate. In summary, the Urban-Brookings Tax Policy Center says:
‘The content of reconciliation laws is limited in the Senate by the Byrd rule, which generally disallows items that do not affect outlays or revenue. The Byrd rule also prohibits initiatives that would increase the deficit beyond the fiscal years covered by the budget resolution.’
Congress passed the American Taxpayer Relief Act of 2012 in response to the expiration of most tax cuts from a decade earlier, which is technically the biggest tax cut in U.S. history, but did not feel like it because it simply made the Bush tax cuts permanent for all but the wealthiest Americans. This resulted in a big tax increase for the top 1% and no change for everyone else.
Despite the Tax Cuts and Jobs Act of 2017, which took effect in 2018, most of the increase in taxes for the top 1% remained. Its biggest breaks went to taxpayers just below them, in the 97th and 98th percentiles, with incomes between $291,384 and $546,434.
As part of the 2012 tax law, AMT exemptions were somewhat increased and indexed to inflation. AMT payers dropped from 5.1 million in 2017 to 170,132 in 2019 after the 2017 law exempted all but the very highest earners from the tax. It constituted a windfall for the HENRYs, but their tax rates were actually higher before it, so it wasn’t a completely ill-timed windfall.
And it wasn’t entirely simple either. Individual income tax provisions were mostly temporary in order to comply with reconciliation rules. According to the Tax Policy Center, the AMT break is set to expire in 2025, which would affect 7.6 million taxpayers. It also didn’t deliver its benefits evenly across the country. HENRYs in low-tax states benefited much more from the AMT changes than those in high-tax states thanks to another provision of the 2017 law that limited deductions for state and local taxes.
The 2017 tax law made permanent changes to the business side, with the most significant change being the reduction of the corporate income tax rate from 35% to 21%. It is not clear how a cut like that affects individual incomes. According to mainstream economic theory, corporate shareholders bear most of the cost of corporate income taxes, and since high earners own most corporate shares, they get most of the tax cuts.
However, some economists contend that corporate taxes burden rank-and-file workers more than investors, since they are less mobile and therefore more susceptible to high rates. It would appear that the income changes since the 2017 law actually support the latter view since both in 2018 and 2019, the proportion of overall adjusted gross income went to the top 1% fell.
So, the 2017 tax cut was not as skewed toward the very rich as the 2001 and 2003 tax cuts. Some Democrats claim it was assumed (1) that the corporate tax burden falls mostly on the highest earners (2) that all temporary provisions would expire, which seems unlikely based on past experience.
While smaller than it was a decade ago, the regressive turn at the top of the income distribution persists. Inflation causes some illusions, though: A $1,000 capital gain from the sale of an asset bought a decade earlier represents not $1,000 in real income, but $809 income and $191 in inflation, based on the CPI.
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There are also economic reasons to keep capital gains taxes low. Meanwhile, the extremely wealthy have ways of reducing their taxable income that we aren’t able to take advantage of, so the above overstates the percentage of their income that goes to taxes.
Over the past decade, the effective tax rate has fallen across the board, resulting in a decrease in individual income tax revenue from 9.4% of GDP in 2001 to 8.1% in 2019. (1) Playing with the taxes of the 1% isn’t meaningless, but it won’t pay all the bills either.
(1) Occasionally, tax cuts do boost GDP, however, there is ‘no glaring’ credible economic model in which tax cuts since 2001 have increased GDP enough to offset their costs and (2) actual GDP growth since 2001 has been dismal with annual gains of just 1.9%.
