We have a new president, with a restless and far-reaching agenda — but how will the nation pay for that agenda?
For John F. Kennedy, elected in 1960, it was taxes and borrowing. For President Barack Obama, to whom JFK is often compared, the answer’s the same: taxes and borrowing.
But with the April 15 filing deadline looming, it’s worth noting that the tax system over which Obama presides isn’t the one workers knew two generations ago when Kennedy was entering the White House.
If you’re 70 today, you may have just retired, but do you recall that when you started working in 1960, making a beginner's wage, you paid only about $70 in payroll taxes? And that was for whole year, not for one week or one month.
The biggest tax change since 1960 is the growth in Social Security and Medicare taxes, also known as payroll taxes.
You may not think about them as you prepare your income tax returns, but for most taxpayers, payroll taxes are a bigger burden than income taxes. According to a report issued last week by the congressional Joint Committee on Taxation, for more than four out of five tax filers, employment taxes are a bigger burden than income taxes.
Growing importance of payroll taxes
And payroll taxes have become a larger source of revenue for the federal government than they were in 1960. Back then, they accounted for 16 cents of every dollar of federal tax revenues. Last year they accounted for about 35 cents of every revenue dollar.
Why? The Social Security tax rate today is more than twice as high as it was in 1960 and the amount of income subject to the tax is far bigger.
In 1960, only the first $4,800 of income was taxed — and at a rate of just three percent. This year the Social Security tax rate is more than twice as high, 6.2 percent, and the first $106,800 of earned income is taxed. (The amount subject to taxation goes up every year, using a formula based on increases in average wages.)
Another reason the payroll tax burden today is heavier than it was in 1960 is that 50 years ago there was no Medicare — and thus no Medicare tax (that didn’t arrive until 1966.)
Workers in 1960 didn’t have to pay the 1.45 percent Medicare tax which workers pay today. And that Medicare tax applies to all earned income, not just to the first $106,800, as the Social Security tax does.
One thing that has not changed appreciably since 1960: the biggest piece of the revenue pie comes from taxes on incomes. In 1960, 44 percent of all federal revenues came from income taxes, while in 2008, 46 percent came from the income tax.
Who bears the tax burden?
But what’s different is that the income tax burden is being carried to a greater extent today by upper-income people than it was 30 years ago, according to an analysis by the non-partisan Congressional Budget Office which tracks data going back to 1979.
In 1979, the top 10 percent of households, as measured by income, paid 40.6 percent of all federal taxes; other ninety percent paid 59.4 percent.
But by 2005, the top 10 percent accounted for nearly 55 percent of all federal tax revenues, while the rest of the population paid about 45 percent.
“In large part this is due to the large increase in the concentration of income, rather than a more progressive tax system,” said Joel Slemrod, the director of the Office of Tax Policy Research at the University of Michigan Business School.
Economists Thomas Piketty of the Paris School of Economics and Emmanuel Saez of the University of California at Berkeley find that the share of income going to the top 0.1 percent of the income distribution "was around 2.5 of total income in the 1970s and reached a peak above 9 percent of total income in 2000. In fact, most of the overall increase in the inequality of income has been driven by the very top of the income distribution...”
Measuring tax progressivity
Piketty and Saez say that “the federal tax system is clearly progressive,” that is, as a person’s income increases, the percentage of his income that he pays in taxes also increases.
One way tax experts use to measure the progressivity of a tax system is the effective tax rate, which is the total tax divided by total pre-tax income.
The Congressional Budget Office study found that a person in the middle of the income distribution (the middle fifth, if you divide the population by fifths according to income) paid an effective federal tax rate of 14.2 percent in 2005, while a person in the one percent of the population with the highest income had a effective tax rate of 31.2 percent.
People in the lowest fifth, or quintile, had an effective tax rate of 4.3 percent, partly because tax law changes in the past ten years removed many low-income people from the income tax rolls entirely. They pay only payroll taxes.
The lessening of the tax burden on the lowest quintile is a big change from 1979. That year, according to CBO, people in lowest income group (the bottom fifth of the income distribution) paid an effective federal tax rate of 8 percent.
But while Piketty and Saez say the tax system is “clearly progressive,” they seem to imply that it isn’t progressive enough, especially when it comes to the very top of the income pyramid.
Their concern is with using the tax code to bring about a more equal distribution of income. They say, “a tax system can be defined as progressive if after-tax income is more equally distributed than before-tax income.”
Using the tax code to re-distribute income more equally is a goal that many — but not all —Democratic members of Congress would support.
Obama has proposed to raise income taxes on upper-income people and to limit the amount that people with income of more than $250,000 a year can deduct from their taxes for charitable contributions.
Since the tax cuts which Congress enacted in 2001 and 2003 are set to expire at the end of 2010, Congress will face a momentous decision next year on tax rates.
Decline in excise taxes
For taxpayers of the JFK era, the tax system was much more targeted at spending than it is today. Excise taxes — the taxes you pay when you buy tires, gasoline, wine, beer, firearms, fishing rods, and other items — have dwindled from 13 percent of total revenues in 1960 to only about 2 percent today.
Why did this happen?
Ken Kies, former chief of staff for the Congressional Joint Committee on Taxation and a tax lobbyist with the Federal Policy Group in Washington, said, “It was not until World War II that individual and corporate income taxes, combined, exceeded federal excise tax revenues. Then in the post-war period, excise taxes settled in at about 13 percent of total receipts, until the mid 1960s when President Lyndon Johnson and Congress cut them.”
And, Kies said, the high inflation of the late 1960s through early 1980s eroded the real dollar value of excise taxes.
Corporate tax less important than in 1960
Another noteworthy change in the mix of tax revenues today compared with 1960 is the decline in corporate tax revenue as a percentage of the total, from 23 percent to 13 percent.
Slemrod noted that in 2006, “corporate income taxes were back up to 15 percent of federal revenues, a level not seen since the late 1970s. The secular decline from 1959 to 2002 was apparently due to a decline in both the share of corporate profits in gross domestic product and a decline in the the effective tax rate.”
Kies partly agreed, noting that “the top corporate rate was a lot higher in the 1960s than it is now.”
But he added the most significant reason is that as a result of the 1986 tax law a lot of corporations converted into entities such as S corporations or partnerships. “As a result, a lot of business income that was previously taxed as C corporation income now shows up as individual income tax,” Kies said.