The accompanying tables update annual estimates by CBO of average tax rates—that is, households’ tax liability divided by their income—and compare those estimates for 2007 with estimates from 2006. This report’s tables show average tax rates for various income categories for the four largest sources of federal revenue—individual income taxes, social insurance (payroll) taxes, corporate income taxes, and excise taxes—and for the four taxes combined. The tables also present average before-tax and after-tax household income; the number of households in each income category; and shares of taxes, income, and households for each fifth (quintile) of the income distribution and for the top 10 percent, 5 percent, and 1 percent of households.
Additional data and supplemental material posted with this report contain information relating to the methodology used to construct the estimates, supplementary estimates for different types of households, and estimates of the number of households that pay more in payroll taxes than they do in income taxes.
In 2007, the overall average federal tax rate was 20.4 percent (see Table 1). Individual income taxes, the largest component, were 9.3 percent of household income. Social insurance taxes (also called payroll taxes) were the next-largest source, with an average rate of 7.4 percent. Corporate income taxes and excise taxes were smaller, with average tax rates of 3.0 percent and 0.6 percent, respectively.
The federal tax system is progressive—that is, average tax rates generally rise with income. Households in the bottom fifth of the income distribution paid 4.0 percent of their income in federal taxes, the middle quintile paid 14.3 percent, and the highest quintile paid 25.1 percent. Average rates continued to rise within the top quintile: The top 1 percent faced an average rate of 29.5 percent.
Higher-income groups earn a disproportionate share of pretax income and pay a disproportionate share of federal taxes. In 2007, the highest quintile earned 55.9 percent of pretax income and paid 68.9 percent of federal taxes; the top 1 percent of households earned 19.4 percent of income and paid 28.1 percent of taxes. The share of taxes paid by high-income groups exceeded their share of income because average tax rates rise with income. In all other quintiles, the share of federal taxes was less than the income share. The bottom quintile earned 4.0 percent of income and paid 0.8 percent of taxes, and the middle quintile earned 13.1 percent of income and paid 9.2 percent of taxes.
Much of the progressivity of the federal tax system derives from the individual income tax. In 2007, the bottom quintile’s average rate for the individual income tax was -6.8 percent, which means that refundable earned income and child tax credits exceeded the income tax owed by that group. On average, households in the second quintile also received more in credits than they paid in individual income taxes. The average income tax rate was 3.3 percent for the middle quintile and 6.2 percent for the fourth quintile. For the highest quintile, the rate was 14.4 percent. The top 1 percent, on average, paid 19.0 percent of their income in individual income taxes.
Average rates for payroll taxes rise gradually across most of the income distribution, then fall at the top. The average payroll tax rate for the lowest quintile was 8.8 percent. That rate was 9.5 percent for the second quintile, 9.4 percent for the middle quintile, and 9.5 percent for the fourth quintile. The increase occurs because nontaxable transfer payments (for example, spending for Medicare, Medicaid, and most Social Security benefits) make up a larger share of income at the bottom of the distribution. The payroll tax rate was 5.7 percent for the highest quintile. That rate is lower than others in part because much of the wages in that quintile are above the maximum income subject to Social Security taxes ($97,500 in 2007) and in part because capital income, such as interest, dividends, and capital gains, is a larger share of income at the top. Social insurance taxes account for the largest share of taxes paid by households in all but the top quintile. The impact of the corporate income tax also rises with income, because CBO assumes in this analysis that the tax is borne by those who receive capital income, and capital income is a larger share of income at the top of the distribution. The incidence of the corporate income tax is uncertain, and various models suggest that at least some of the tax is borne by workers in the form of reduced earnings, in which case the tax would not be as progressive as shown in CBO’s analysis. The effect of excise taxes, relative to income, is greatest for lower-income households, which tend to spend a greater proportion of their income on such goods as gasoline, alcohol, and tobacco, which are subject to excise taxes.
Average tax rates in 2007 changed only slightly from those in 2006 (see Table 2). There were no significant changes in the income tax law between those years, and differences in the income distribution were not enough to cause large changes in average rates. The overall average rate fell by 0.3 percentage points from 2006 to 2007. The largest contributor was a decline of 0.5 percentage points in the average corporate tax rate, which was caused by falling corporate profits and associated reductions in taxes. Payroll taxes also fell by 0.1 percentage point, mainly because of rapid growth in wages above the Social Security taxable maximum. Excise taxes fell by 0.1 percentage point, largely because of changes in the telephone excise tax. Those declines were partially offset by an increase of 0.2 percentage points in the average individual income tax rate, which occurred in part because real income growth pushed more and more income into higher tax brackets.
The changes in average tax rates from 2006 to 2007 were uneven across income quintiles. The rate for the lowest quintile declined by 0.5 percentage points, largely because of declining excise taxes. The second quintile’s average tax rate increased by 0.4 percentage points, as rates for both the individual income tax and the payroll tax crept up. The average rate for the middle and fourth quintiles changed only slightly, reflecting an increase in the average rate for individual income taxes and small decreases in the average rate paid for other taxes. The largest decline in average tax rates—0.7 percentage points—applied to taxpayers in the highest quintile. That change was attributable mostly to the reduction in payments of corporate income taxes. The pattern continued up the income scale; the average rate for the top 1 percent declined by 1.8 percentage points, mostly because of lower corporate income taxes.
CBO uses a multistep methodology to estimate the distribution of income and taxes on the basis of data contained in the Census Bureau’s Current Population Survey (CPS) and in the Statistics of Income (SOI) recorded by the Internal Revenue Service. CBO estimates federal taxes for each household in the sample on the basis of income, demographic characteristics, and existing laws in the relevant year. Households are then grouped into quintiles on the basis of income, and then income, taxes, and average tax rates (the amount of tax liability divided by income) are tabulated for each quintile.
CBO’s analysis of average tax rates draws information on income from two primary sources. The SOI samples more than 300,000 individual income tax returns and reports much of the information that taxpayers provide on those returns. The March supplement to the CPS contains data on demographic characteristics and income for almost 100,000 households.
CBO statistically matches each SOI record to a corresponding CPS record on the basis of demographic characteristics and income. The matching process begins by dividing all records in the CPS and the SOI into demographic subgroups by household composition, considering the marital status of the head of the household, the number of children, and the number of elderly members. Because income measures in the SOI and CPS are not directly comparable, CBO uses a regression equation for each demographic subgroup (estimated using data from the SOI) to calculate a predicted income for each record for each source of data. All CPS and SOI records are ranked by predicted income within demographic subgroups, and the two files are then matched, starting at the top of the income distribution: The SOI record with the highest predicted income is matched with the CPS record with the highest predicted income—after their sample weights are taken into account. The SOI record with the next highest predicted income is then matched with the corresponding CPS record, and the process is repeated until all SOI records in the demographic subgroup have been paired with CPS records.
Each pairing results in a new record that takes on the demographic characteristics of the CPS record and the income reported in the SOI. Some types of income, such as most transfer payments and in-kind benefits (such as employer-provided health insurance, Medicare and Medicaid benefits, and food stamps), appear only in the CPS; values for those items are drawn directly from that survey. Because not all households must file tax returns, some do not appear in the SOI; thus, the CPS reflects more households. After all SOI records have been matched to CPS records, the remaining survey records are recorded as nonfilers, and the income values are taken directly from the CPS. CBO then estimates the tax liability for each matched record. The SOI record with the next highest predicted income is then matched with the corresponding CPS record, and the process is repeated until all SOI records in the demographic subgroup have been paired with CPS records.
CBO’s analysis of average tax rates assumes that households bear the burden of the taxes that they pay directly, such as individual income taxes (including taxes on interest, dividends, and capital gains) and the employee’s share of payroll taxes. The analysis assumes—as do the analyses of most economists—that the employer’s share of payroll taxes is passed on to employees in the form of lower wages than would otherwise be paid. Therefore, the amount of those taxes is included in employees’ income, and the taxes are counted as part of employees’ tax burden. CBO estimates payroll taxes and individual income taxes, including refundable tax credits, by applying the tax law for the relevant year to each of the sample tax returns from the SOI.
Excise taxes are assumed to fall on households according to their consumption of taxed goods (such as gasoline, tobacco, and alcohol). Excise taxes that affect intermediate goods, which are paid by businesses, are attributed to households in proportion to their overall consumption. CBO assumes that each household spends the same on taxed goods as is spent by similar households that are shown in the Consumer Expenditure Survey to have comparable income.
Far less consensus exists about how to attribute corporate income taxes (and taxes on capital income generally). In this analysis, CBO assumes that corporate income taxes are borne by owners of capital in proportion to their income from interest, dividends, capital gains, and rents. Over the long term, however, some models suggest that at least part of the burden falls on labor income.
This analysis focuses on households’ adjusted pretax comprehensive income, which includes all cash income (taxable and tax-exempt), taxes paid by businesses (which are imputed to individuals, as noted above), employees’ contributions to 401(k) retirement plans, and the value of in-kind income received from various sources (such as employer-paid health insurance premiums, Medicare and Medicaid benefits, and food stamps). The calculations use the Census Bureau’s fungible value measure to determine the cash equivalent of Medicare and Medicaid benefits.
In a series of steps, CBO combines the income and taxes of households to create tables showing distributions of income and taxes among income groups and types of households. The first calculation adjusts for household size by dividing household income by the square root of household size to take account of the differing needs of larger and smaller households. Then, households are ranked by their (adjusted) income and grouped into quintiles that contain equal numbers of people (because household sizes vary, however, separate quintiles generally contain different numbers of households). Overall income and taxes are tabulated for each quintile and for smaller groupings at the top of the distribution.
Separate tables, available on CBO’s Web site, show average tax rates and income for three types of households: those with members under age 18 (households with children), those headed by a person age 65 or older and with no member under age 18 (elderly childless households), and all others (nonelderly childless households). The tables group households into quintiles by position in the income distribution within the entire population, not within each of the three types of households, so each type of household need not be evenly spread across the income quintiles.