Today's federal income tax system is highly progressive,
with taxpayers at the top of the income spectrum paying higher
rates than those in the middle and bottom. The current tax code has
six tax brackets with rates ranging from 10 percent (for taxable
income up to $16,700) to 35 percent (for taxable income above
$372,950 for married couples).
President Barack Obama's budget and the budget resolution
adopted by Congress would further increase progressivity
by raising the tax rates of married couples who earn more than
$250,000 a year and singles who earn more than $200,000.
Progressivity discourages hard work, savings, investing, and
entrepreneurship. Discouraging these catalysts of economic growth
is always counterproductive, but doing so during a severe
economic recession is particularly irresponsible.
To make the tax code less progressive and encourage
economic growth, Congress should scrap plans to increase tax rates
on top earners and instead reduce the number of brackets and lower
the rates on those that remain.
Income Tax Highly Disproportionate
A decreasing number of high-income taxpayers are increasingly
paying the entire income tax bill. According to the
Congressional Budget Office (CBO), the top 20 percent of all income
earners paid 86.3 percent of all income taxes in 2006. This
was an all-time high and significantly higher than in 2000, before
the 2001 and 2003 tax cuts went into effect.
The drastically progressive income tax code means that
high-income taxpayers pay disproportionately higher taxes
compared to lower-income taxpayers. Take the average family of
four, which qualified for the top quintile of income earners if it
earned at least $142,000 in 2006 (the most recent year for which
data are available). For 2006, the family paid income taxes of
$20,078, and its effective income tax rate-total income taxes
paid after deductions and credits divided by income-was 14.1
percent. (See Chart 1.)
A family of four that earned the minimum amount to be included
in the second-highest income quintile made $94,800. Its effective
income tax rate was 6.0 percent-less than half the top quintile's
rate-and its tax bill was $5,688.
Even though the family in the top quintile earned 50 percent
more than the family in the second quintile, it paid 253
percent more in income taxes. (See Chart 2.)
The statistics are even more astounding when one compares a
family in the top quintile to families in the middle and lower
quintiles. A family of four that earned $64,200, the minimum amount
to be classified as middle income, had an effective income tax rate
of 3 percent-almost five times lower than the top quintile's
rate-and paid $1,926 in income taxes.
The family in the top quintile's income was 122 percent higher
than the middle-income family's, but they paid a staggering 943
percent more in income taxes.
Compared to the bottom 40 percent of income earners, taxpayers
in the top quintile pay much higher taxes because taxpayers in the
bottom two quintiles generally pay no income taxes at all.
In fact, they receive payments through the tax code in the form of
The effective income tax rate for a family of four in the bottom
quintile that earned up to $37,800 was -6.6 percent. This means
that the average family in this quintile received
almost $1,300 in income through the tax code.
An average family of four in the second-lowest quintile had an
effective income tax rate of -0.8 percent. This family earned up to
$64,200 and received an average of $408 of income through the tax
Progressivity Knows No End
It is obvious that high-income families pay substantially
higher taxes than low and middle-income families pay, but the tax
code is also highly progressive among high earners because rates
continue to rise. In 2006, the top 35 percent rate kicked in at
$336,550, which is above the threshold for a family of four to
qualify for the top 5 percent of earners. As taxpayers move
into higher income brackets, they lose the ability to take certain
deductions, and the alternative minimum tax (AMT) reduces the
value of other deductions.
A family of four that earned enough to be in the top 1 percent
of all income earners made $664,600 in 2006 and paid an effective
income tax rate of 19 percent. Its tax bill for the year was
A family that made enough to qualify for the top 5 percent of
income earners made $268,800 and paid an effective income tax rate
of 17.5 percent. Its tax bill was $47,040.
The family in the top 1 percent earned 147 percent more than the
family in the top 5 percent but paid 168 percent more in
taxes. (See Chart 3.)
The difference is even larger when comparing a family in the top
10 percent to the family in the top 1 percent. A family in the
top 10 percent earned $196,200 in 2006 and paid $31,392 in taxes
for an effective income tax rate of 16 percent. The family in the
top 1 percent earned 239 percent more than this family-and paid
more than 300 percent more in taxes.
Progressive taxation dampens economic growth because it lessens
the incentives of investors, savers, and entrepreneurs to take on
new risk and reduces incentives for workers to put in longer hours.
People work longer hours and extra days to earn
additional income, and progressive taxation means they keep
less of what they earn as their income rises. Not surprisingly,
many workers decide that the extra effort is not worth it.
Savers and investors forgo spending their income today for the
chance to earn high returns in the future, but progressive taxation
means that as their returns increase, they pay higher tax rates and
their after-tax returns decline. This makes spending their income
now more attractive, and both investment and savings decline.
The risks of starting a new business are high, but the rewards
often outweigh those risks-and not just for entrepreneurs. Workers
and the economy as a whole benefit when entrepreneurs take on new
risk, because the small businesses they create provide jobs
for millions of Americans and often grow into larger businesses
that create even more jobs.
Small businesses rely heavily on the profits they earn in the
early stages of their development to fund growth and expansion.
Progressivity takes more and more of these much-needed profits as
businesses grow. This creates an entry barrier for many would-be
entrepreneurs, discouraging many of them from taking risks to bring
their ideas to market.
Stop Progressivity Now by Making Taxes
Even though the tax code is already steeply progressive,
President Obama proposed in his budget, and Congress adopted in its
budget resolution, a measure to make it even more punitive by
raising the income tax rates for couples earning over $250,000 a
year ($200,000 for singles) back to levels that applied before
the 2001 and 2003 tax cuts. Under this plan, the top two rates will
be 36 percent and 39.6 percent, compared to today's 33 percent and
To avoid increasing the damage that tax progressivity has
already done to the economy, Congress should:
- Abandon the plan to raise tax rates on top earners
and extend the 2001 and 2003 tax cuts for all taxpayers, and
- Reduce the progressivity of the tax code by
eliminating severalbrackets and lowering the rates on those
Congress should aim for a tax code that treats taxpayers more
equally: one that more closely resembles a flat tax. A tax code
that has fewer tax brackets and lower rates would not punish
success as a progressive taxation scheme does. It would tax all
income similarly, so there would be no impediment to earning
Under a flatter tax system, those who earn more income still pay
more taxes than those who earn less, but that difference will be
more proportional to income. Under a flat tax that taxes all income
at one rate, a family that earned 100 percent more than another
family would pay 100 percent more in taxes-not nearly 1,000 percent
more, as is the case under the current tax code.
Increasing the progressivity of the tax code threatens to
further stifle economic growth. A code more in line with the flat
tax is necessary to remove the barriers that block entrepreneurship
and innovation. Regrettably, President Obama and Congress have
chosen to follow liberal orthodoxy and put up more road blocks to
economic growth by increasing the progressivity of the tax code
through higher rates on top earners. They should look to the flat
tax for inspiration instead.
Curtis S. Dubay is a Senior
Analyst in Tax Policy in the Thomas A. Roe Institute for Economic
Policy Studies at The Heritage Foundation.