A View into U.S. Taxes

With the recent U.S. Supreme Court decision upholding the constitutionality of the the Patient Protection and Affordable Care Act, and the ensuing uproar around the dangers of a “new type of tax”, I’ve been thinking a bit recently about the maximum sustainable tax rate for a given country. So I started to do some digging, and what I found was (at least to me) very surprising.

U.S. Tax Complexity

It will come as absolutely no shock to any American that U.S. taxes are preposterously complex. So much so that it’s nearly impossible to figure out what one actually pays in taxes oneself, let alone what an average tax might be. I’m not just talking about the complexity of Federal tax returns — which indeed can be ridiculously complex on their own. But then consider that 43 states and the District of Columbia each impose an income tax. There’s an additional income tax in many municipalities. Add to that sales tax (45 states) and property tax, which also vary by municipality (roughly 88,000) and one starts to see how truly complex taxes in America are. But that’s just getting started. There are inheritance and estate taxes. Depending on what one consumes, there are taxes on vehicles, cigarettes, alcohol, etc…, etc…. And then there’s the implied burden of corporate taxes, which get passed along as a truly invisible cost to consumers.

This results in tremendously wide disparities in taxes, depending upon where and how one lives. Do you drive a car? Do you buy a new one every 4 years? Let’s say it’s a $27,000 car bought new, weighing 3,522 pounds; a four-door, six-passanger car, with an eight-cylander engine. Why does one have to specify that? Because different states and municipalities tax differently — some on gross vehicle weight, some on value, some on class of vehicle, or some combination of all of those things. If you bought that car, you wouldn’t pay any tax at time of purchase in Alaska, Montana, New Hampshire, or Oregon. But you’d pay $1,953 in combined sales and excise taxes in Indiana, New Jersey, Tennessee, Rhode Island, and the District of Columbia. But then every year you have to register that car, and registration fees would vary from $8/year in Arizona to $217/year in Montana. Oh, and then you’d presumably want to drive it. Motor fuel tax rates range from $0.08/gallon in Alaska to $0.461 in California.

So, it depends on where you live and how much you drive, but you could easily be spending a few thousand dollars a year in taxes just to be driving. Do you smoke a pack a day of cigarettes? You’re taxed $62/year for that in Missouri, and $1,262.90 in Rhode Island. Taxes on hard liquor range from $1.50/gallon in Maryland to $12.80 in Alaska. You don’t drink the hard stuff, you say? OK. For beer you’re paying $0.02/gallon in Wyoming, but up to $1.07 in Alaska.

So just how much are Americans paying in taxes? The below chart shows how the tax burden would be broken down for a hypothetical family of four in 2009, with a total income of $50,000.

A chart of tax by tax type, for a hypothetical family of four in 2009, with a $50,000 income.

2009 Tax Burden by Tax Type, $50k Income Family of Four

Tax Trends

Once one gets past the inherent complexity of the U.S. tax base and has some reasonable figures, it’s possible to start looking at trends. The first place I chose to look was at the aggregate data and compare across income levels. This next chart summarizes exactly that.
Graph of Average U.S. Tax Burden by Income Level

It’s not surprising at all that the more money you make, the more you pay in taxes across all categories. The items that I find interesting in this cut of the data are to do with local (state and municipal) taxes. If you watch the news and listen to the public debates, you would think that the Federal government is taxing the middle class to death. However, the reality of the situation is that across all income levels, local taxes exceed Federal taxes. Equally poignant is the distribution of tax at the $25,000 income level. Thinking about a family of four at that income level I’m both impressed with how low the Federal tax is, and shocked at what a substantial part of the family’s income would be devoted to local taxes.

Once I’d gone through the trouble of locating all this data, I thought it might be worth looking at it in another way: across time. Once again, I had some surprises in store.

A graph of total tax burden as percentage of income level, over time.

Tax Burden over Time by Income Level

We hear debates about the criticality of extending the currently temporary tax cuts, and perhaps extending those cuts is, in fact, critical. But those cuts were Federal actions. When you combine social security, Federal income, and state and local income, property, and auto taxes you can get a picture of the total tax burden. And that total tax burden, again, at every income level, has been slowly yet steadily, year over year consistently decreasing for over a decade. Perhaps it’s just me. Perhaps everyone else in the U.S. knows that they’re paying less in tax than they were last year, and a lot less than they were a decade ago. But for me, I have to say this came as a surprise. I don’t feel it viscerally. And it certainly isn’t something that is regularly discussed in the news.

But that wasn’t the end of the surprises for me. What happens if we rotate this chart? That is to say, what does it look like if instead of comparing taxes by year at each income level, we compare taxes by income level across the years?

Tax Burden by Year

Tax Burden by Income Level across Time

Just to make it perfectly clear, let’s add some trend lines:

Graph of trends in tax burden across time by income level.

Trends from 1997 to 2009 in Tax Burden by Income Level

That’s right — not only are taxes decreasing across all income levels, they’re also converging. In 1997 the difference between the lowest tax payed and the highest tax payed was 4.6 percentage points. In 2009, the difference was 3.1 percentage points. That is to say, the difference between taxes payed as a percentage of income has compressed by 32.6%. At this rate, it won’t be very long at all before the U.S. is effectively on a flat tax. In fact, with only a 3% difference between those making $25k and those making $150k, you might as well call it a flat tax now.

I’m not going to make any political arguments about whether or not a flat tax is a good idea. However, given that we’re rapidly approaching the point of having an effectively flat tax rate, it’s at least worth investigating the question of whether all of the tax code complexity at the local, state, and national level is generating sufficient benefit to justify the societal cost of the 100s of thousands of people dedicated to nothing other than tax collection within government at the various levels. The complexities of the tax code are there to drive certain behaviours — whether those behaviours be to get married or not, to quit smoking, to grow corn instead of sugar cane, or whatever other thing we value as a society. But let’s not understate it. When I say, “complexities”, I mean complexities. According to the US Government Printing Office, Title 26 (the part of the US Federal law and regulations dedicated just to income tax) runs to 16,845 pages.

While the burden of complying with all those words has been calculated in different ways, [National Taxpayer Advocate Nina E.] Olson multiplied the IRS’ own estimates of how much time taxpayers spend collecting data for and filling out each individual tax form by the number of forms filed to estimate that Americans (both individuals and businesses) spend 6.1 billion hours a year complying with the code.

And, of course, that’s just the Federal code. I’ll leave it as an exercise for the reader to decide if that’s a good use of societal wealth, or, you know, maybe we could just have an 8.5% state income tax, 6.5% Federal income tax, and 7.5% social security tax … since that’s what we seem to be doing anyhow.

That’s a decent look at the middle class. On the next page, I’ll take a look at the rich.

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Chris Richardson has strong opinions on just about everything. Just ask.