March 7, 1994 | Backgrounder on Taxes
No. 981 I The Heritage Foundation 214 Massachusetts Avenue N.E Washington, D.C. 20002-4999 (202) 5 46-4400 The Thomas A. Roe Institute for Economic Policy Studies March7,
The federal government has put America's families under financial siege. Middle income as well as blue collar families are finding it hard to buy a first home or pay for their children's college tuition. To a large degree, this is because of an explosive rise in the burden of federal taxation.
In 1950, the average American family with children paid only 2 percent of its income to the federal government in taxes. Today that same family pays 24.5 percent.
The average family now loses $10.060 per year of its income due to the increase in F5 federal taxes, as a share of family income. This tax loss exceeds the annual cost of the average home mortgage.
A are included the government now takes 37.6 percent of are not aware that they are really working to support Uncle raise their famiy''s standard of living. Among marrieci-couple families the husband and wife are employed, two-thirds of the wie''s earnings go family wi th children federal taxes; only one-third goes to supporting the family 1 2 These figures include federal income and Social Security taxes.
This figure includ es federal income tax. Social Sdty taxes, fedaal indirect taxes, and state and local taxes. The author wishes to thank Chris Edwards of theTax Foundation for providing this infonnation Note: Nothing written here is to be construed as necessarily reflectin g the views of The Heritage Foundation or as an attempt to aid or hinder the passage of any bill before Congress.
A If federal taxes as a share of family income were restored to the 1950 levels, the aver age employed mother in a two-parent family could lea ve the labor force entirely and the family would see only a modest drop in post-tax income, compared with the fam iy''s post-tax income under tody''s tax rates.
During the past four decades, the federal income tax burden on a family of four has in creased by over 300 percent as a share of family income. Single Americans and married couples with no children have escaped most of this tax increase.
Measured by average after-tax per capitaincome, families with children now are the lowest income group in America. Their average after-tax income is below that of eld erly households, single persons, and couples without children.
The family is the core of American society. It is the principal mechanism through which values, knowledge, discipline, and motivation ar e passed from one generation to the next. The family almost alone molds the character of future generations, and thus it serves as the foundation of civilized life. If the family is weakened, government pro grams cannot repair the damage. But rather than b olstering the American family, the gov ernment actually undermines it. The ever-increasing government tax burden on families with children must be reversed if American society is to regain its health and vitality Clintn''s Promises During the presidential campaign, candidate Clinton charged that "The Republicans who run the federal government have abandoned working families. Millions of Ameri cans are runnin harder and harder just to stay in pl ace middle class families pay more and earn less As a solution , Clinton promised to reduce the taxes paid by families with children stating Virtually every industrialized nation recognizes the importance of strong families in its tax code; weahould too. We will lower the tax burden on middle class Americans This them e was repeated in the book Putting People First, by Bill Clinton and Al Gore, where the authors again promised to "grant additional tax relief to families with children.**5 The Kasich Budget Plan creases in federal spending and has increased taxes on middl e class families6 Fortu- nately, Representative John Kasich (R-OH) has developed an alternative budget, which fulfills Clintn''s promise to cut taxes for families with children. The Kasich budget plan will provide a $500 tax credit for each child in a fami l y. All families with children who Since coming to office, however, President Clinton has instead proposed enormous in 3 4 Ib id p. 9 5 6 Putting People First: A National Economic Strategy for America Clinton campaign document. p. 8 Bill Clinton and AI Gor e. Putting People First (New York Times Books, 1992 p. 100.
Robert Rector Resident Clintn''s Commitment to Welfare Reform Ihe Disturbing Record So Far Heritage Foundation Buckgrounder No. 967, December 17,1993 2 pay taxes and have incomes below $200,000 wi ll be covered by the plan? Under the plan, a family with two children will see its taxes cut by $l,OOO and its post-tax income raised by $l,OOO In effect, the Kasich plan puts $500 in the pocket of parents for each child in their family HOW WASHINGTON HAS HIKED TAXES ON CHILDREN Federal taxation of families with children has increased dramatically over the past four decades In 1948, the typical family of-four paid just .two percent of its income to the fed eral government in direct taxes8 In 1992 the equiv alent family paid nearly 24.5 percent of its income to the federal government.
As Chart 1 shows, when state and local and in direct federal taxes are included, the tax burden on that family equals 37.6 percent its in come.
The rise in federal income taxes on families with children in the last four decades has been much faster than for other groups of Americans The root cause of this growing anti-family bias in the federal income tax code is the eroding value of the personal ex emption. The personal exempt i on for children was intended to offset part of the annual costs of raising a child by allowing families to deduct an amount of money from their tax able income. In 1948, the personal exemption was $6OO.This was equal to roughly 17 percent of the median in c ome of a family of four, then $3,468.12 For the average family the $600 personal exemption shielded 68 percent of family income from federal income tax. Families could reduce their tax bill further by itemizing deductions or taking the standard deduction, and this protected most of the remaining 32 percent of income from income tax. The result: in the late 1940s and early 1950s the average family with children paid little or no income tax.
In the past four decades, however, increases in the personal exempt ion have lagged far behind the rise in incomes and inflation. Chart 2 shows the declining value of personal exemptions relative to the income of the average family of four. As the value of the per sonal exemption has declined, the income tax paid by famil i es with children has in 9 10 creased. l3 7 8 9 10 11 12 13 The Kasich tax credit can be used to reduce a paret''s income or Social Security taxes. Parents who pay little or no income tax will have their Social Security tax redd, however. these parents wil l continue to receive full credit toward retirement under the Social Security system. Working families who pay no taxes would not receive funds under the Kasich plan but these families already receive up to $3.500 through the earned income tax credit.
The value of the personal exemption also declined between the imposition of the federal income tax in 1913 and World War II. But 1948 is chosen as a benchmark because it is neither a depression year nor a war year, and because it marks the beginning of a long perid of high inflation and rising taxes.
These figures represent the tax rates for a family of four at the median family income level for two-parent families.
Estimate based on data supplied by US. Bureau of the Census.
See Robert Rector, "How to Strengthen Ameria''s Crumbling Families Heritage Foundation Backgrounder No 894, April 28,1992.
Mary F. Henson. Trends in Income, by Selected Chamcferisrics: 1947 to 1988, U.S. Bureau of the Census, Current Population Reports, Series P-60, No. 167 (Washington, D.C.: U.S. Government Printing Ofice, 1990 p. 19.
For the personal exemption today to have the same value relative to family income that it did in 1948, it would have to be about $7,000 in 1992 and an estimated $8,000 in 1996 3 The second tax blow to family finances has been the increase in Security Social taxes technically known as payroll taxes. In 1948, workers paid a two percent Social Secu rity tax on annual wages of up to $3,000: one percent was paid directly by the employ ee and one percent paid indirectly by the employer through the so-called employer share l4 By 1992, combined Social Security taxes had risen to 15 percent of wages on incomes up to 55,5
00. While all workers have suffered from skyrocketing Social Security taxes the bite has been most severe on working families with children. The reason for this is that Social Security taxes, unlike regular income taxes, are not adjusted for the number of dependents in a family So a working parent trying to support a family of four feels the sting of this tax far more sharply than a single person at the same wage level. The ef fect of Social Security taxation is particularly severe on lower-income parents; a family with an income of 25,000 per year, for instance, pays $3,750 in Social Security taxes.
Moreover, Social Security taxes on todays young parents greatly exceed the real value of any retirement benefits they will receive from the system l5 eral taxes as a share of median family income.16 In 1948, effective tax rates e qualled 2 percent of income for the average family of four. By 1970, they had risen to 16 percent by 1992 to 24.5 percent Chart 4 shows the pre-tax and post-tax income for average family of four between 1948 and 1992.17 All figures are adjusted for inflat i on. As the chart makes clear, the growth of pre-tax family income since the late 1960s has slowed. At the same time the tax bite or share of family income taken by the IRS has increased enormously Taxing Families Out of House and Home. The income loss due to increased taxa tion has seriously strained American family finances and profoundly affected American family life Chart 5 shows the effects of increases in federal income and Social Security taxes since World War ?I on the finances of the average family . Total pre-tax income for the median family of four in 1992 was $47,787.18 After taxes this familys income fell to 36,9
15. If federal taxes as a percentage of family income were restored to 1948 levels the familys post-tax income would have been $46,9
7 5. For the median-income Ameri can family, the loss of income in 1989 because of the increase in federal taxes as a share of family income, due to the falling value of the personal exemption and the rise in So cial Security taxes since the late 194Os, was $10,060 The Government Assault on Family Income. Chart 3 shows the growth in direct fed 14 Liberal and conservative economists agree that both shares of the Social Security tax are in fact direct taxes on workers wages Sa Joseph A. Pochman and Benjamin A. Okner, Who Bears the Tu Burden? (Washington, D.C The Brookings Institution, 1974). pp. 25-43 15 Peter J. Fmara, Social Security: The Inherenr Contradiction (Washington, D.C The Cat0 Institute, 1980 16 Social Security and income taxes as a share of the med i an income for a family of four in each year. Henson. op. cir p. 21 and other data provided by the Bum of the Census.Tax calculations from Heritage model, assuming that families claim itemized deductions equal to 23 percent of gross income through 1986 and 18 percent thereafter 17 Pre-tax income includes the so-called employers sham of Social Security tax which is deducted from parents wages. The tax burden calculated includes income tax and both shares of Social Security tax 18 Data from the U.S. Bureau of the Census. Total pre-tax family income includes the employer share of Social Security tax deducted from the parents wages 4 This income loss severely affects the ability of families to support themselves. The me dian price of a single family home purchas ed in 1992, for instance, was $103,700.The average annual mortgage payment on such a home (including principal and interest) was 7,3
80. Thus, the annual family income loss due to increased federal tax rates for the average family in the last four decades actually exceeds the annual cost of an average family home mortgage.
Family Time Famine. The loss of income due to rising taxes also helps explain why so many mothers have felt compelled to join the work force to make ends meet. For the average family in which both the husbandand wife equal about 34 percent of total family hcome2 The average employed mother, juggling her job and family demands, knows only too well that despite her efforts the paychecks she brings home do not seem to be raising her familys living standard very much. The reason: only about one-third of her earnings actually are taken home for the familys budget. The remaining two-thirds of todays mothers earnings pay the higher federal taxes on family income levied since World War II. In fac t, if federal tax rates as a percent age of family income were restored to 1948 levels, and if the average employed mother in a two-parent family were to leave the labor force entirely, the family would see only a moderate dip in real post-tax income.
Charts 6 and 7 show why this is so. Average total pre-tax income in 1992 in families where both spouses were employed was $55,9
08. Of this, the husbands average eam ings were $36,455 and the wifes average earnings were $19,453.2 After federal taxes post-tax income for this family fell to $42,4
12. If federal tax rates as a percentage of fam ily income were restored to 1948 levels, the familys post-tax income would be $35,725 if only the husband worked, and just $6,687 less than the familys current post-tax i n come today with both spouses working. Thus nearly two-thirds of the employed wifes average earnings go to pay for increased taxation; only one-third to support the family.
This does not mean that all employed mothers would want to leave the labor force if taxes were lowered to earlier levels. But it does show strongly that rising federal taxation is a key factor in the financial and personal strains that force many mothers reluctantly into the work force. It also helps to explain why parents today typic a lly spend 40 percent less time interacting with their children than did parents in earlier generations. While par ents in 1965 spent 30 hours per week in direct contact with their children, by 1985 such time spent with children had dropped to just 17 Surv e ys indicate that the pressure on parents to work harder and longer to keep the family financially afloat is eroding the quality of family life. A 1988 USA T&y survey found that 73 percent of two-parent families would choose to have one arent remain at hom e full time to care for their children if money were not an issue.A 1989 survey employed, the wifes earnings 19 Data provided by the National Association of Realtors 24 U.S. Bureau of the Census, Earnings ofMurried-Couple Families, Current Population Repor ts. Series P-
60. No 165 (Washington, D.C U.S. Government Printing office, 1989 pp. 8,9 21 tax income figures include the employers share of Social Security tax. Data from the U.S. Bureau of the Census 22 William R. Mattox Jr The Parent Trap, Poky Review, Winter 1991, p. 6 23 Ibid 5 by The New York Times found that 72 percent of employed fathers and 83 percent of em ployed mothers feel tom between the demands of their jobs and their desire as parents to spend more time with their families. A 1989 Cornel1 U n iversity study discovered that two-thirds of mothers employed full time would prefer to work fewer hours in order to devote more time to family life. And over half of the fathers and mothers surveyed in a similar Los Angeles Times poll conducted in 1990 s t ated that they feel guilty about spend ing too little time with their ~hildren.2 CONCLUSION PROVIDING FAMILY TAX RELIE Americas often disparaged traditional two-parent family is the principal social institu tion by which the work ethic, self discipline, i ntellectual motivation, and moral character are passed on to the next generation. The American family is the foundation of American society. When the family is weakened the nation is weakened.
But the American family is in deep trouble. A crushing tax burden is making it increas ingly difficult for middle-class families to support themselves. What families need from government is not new spending and new social programs. Those have done little o r noth 1 ing to help families, and paying for them merely has added to the tax burden on these same families. The best way for the federal government to strengthen families and assist parents in their vital role of raising the next generation of Americans is to reduce their tax burden.
Fortunately, Representative Kasich has developed an alternative budget that fulfills Clintons promise to cut taxes for families with children. The Kasich budget plan will provide a 500 tax credit for each child in a family A ll families with children who pay taxes and have incomes below $200,000 will be covered by the plan. Under the plan, a family with two children will see its taxes cut by l,OOO and its post-tax income raised by $l,OOO. In effect, the Kasich plan puts $500 in the pocket of parents for each child in their family. Families with children need and de serve the Kasich family budget.
Robert Rector Senior Policy Analyst 24 Ibid 25 To understand family tax relief it is important to note the difference between a tax credit and a tax exemption. With an income tax exemption. income equal to the amount of the exemption is exempted from income tax. Thus for a family in the 15 percent income tax bracket, a $500 increase in the personal exemption decreases taxes owed by 75 . By contrast. under a tax cdit the amount of the credit is deducted from the taxes paid. It directly reduces tax liability. Thus for the same family in the 15 percent income tax bracket, a $500 tax credit decreases net taxes by 5
00. And because a tax cre dit can be applied to both income and Social Security taxes, it is the better way to reduce the tax burden on modest-income families 6 Total Federal, State and Local Tax Burden on a Median 1ncome-FamMy.af four in I992 Post=Tax Income Total Tax Burden 7 Sh are of Family Income Shielded from Federal Income Tax by Personal Exemptions 80 60 40 20 Percent of Family Income I.
I 1950 1955 1960 1965 1970 1975 1980 1985 1990 Source: Heritage Tax Model, income data from U.S. Bureau of the Census. I 8 Chart 3 Federal Taxes as a Share of Median Family Income 1948-1 992 Federal Taxes as Share of Gross Income 30%1 I 25 20 15 IO 5 1950 1955 1960 1965 1970 1975 1980 1985 1990 Note: Figures are for a median income family of four Source: Heritage Tax Model, income data from U .S. Bureau of the Census 9 t Income and Federal Taxes for a Family of Four: 1948-1992 1950 1955 1960 1965 1970 1975 1980 1985 1990 of the Census 10 Chart 5 Average Income Families Would b ''Taxed 10,060 per Year less if Federal Tax Rates Were Returned to 1 948 levels Income Lost to Taxes 812 Income Lost to 1948 Tax Rates 812 me Lost to Increased Tax Rates 10,060 1948 Tax Rates 1992 Tax Rates Source Heritage Tax Model, income data from U.S. Bureau of the Census. Data for a median family of four 11 Chart 6 Hu sbad''sEarnings Wie''s Earnings Post-Tax Income 70 60 50 30 20 IO Rising Federal Taxes Now Both Parents Must Work housands of I992 Dollars Pre-Tax Income Post-Tax Income Pre-Tax Income Post-Tax Income Husband Only Employed.
I948 Tax Rates Both Spouses Employed I992 Tax Rates Note: Average I992 income. Pre-tax income includes employer share of Social Security.
Source: Heritage Tax Model, income data from US. Bureau of the Census 12 Chart 7 Increased Federal Taxes Consume 65% of the Family Income Provided by Working Wives Increased Federal Taxes on Both Parents Earnings ax Gain y Income Wie''s Employment Source: Heritage Tax Model, income data from U.S. Bureau of the Census 13