A study by White House economists released on September 23 found that the 400 wealthiest U.S. families paid an average income tax rate of just 8.2 percent from 2010 to 2018. This column examines how that low tax rate compares with what ordinary people pay, using six examples of typical workers and families. It illustrates how wages are taxed at higher rates than income derived from wealth and demonstrates how this tiered rate system benefits the richest members of American society. Congress has a rare chance to fix these fundamental problems by passing the Build Back Better agenda, which would expand tax credits for working families and reform the tax treatment of income from wealth.
The Forbes 400 paid an average income tax rate of 8.2 percent from 2010 to 2018
The study, by economists Greg Leiserson of the Council of Economic Advisers and Danny Yagan of the Office of Management and Budget, used annual “Forbes 400” lists and public data to estimate the incomes and federal income taxes paid by members of that elite group. The main reason the top 400 pay such a low tax rate is that a very large share of their income is in the form of unrealized capital gains—appreciation in the value of their assets, mostly stocks and other business interests. Because of a tax code feature known as “stepped-up basis,” unrealized gain on an asset is never subject to income tax if the asset is not sold during the owner’s lifetime. As a result, much of the income of the wealthiest families in the country never appears on their income tax returns.
See also
In contrast to the White House analysis, many effective tax rate measures exclude unrealized gains, meaning they are incomplete when it comes to the very wealthy. The measure of income used in the White House study—one that includes unrealized gains—provides a broader perspective. This approach to measuring income comes close to the concept known as “Haig-Simons” income: consumption plus change in net wealth. The congressional Joint Committee on Taxation has said that, “Economists generally agree that, in theory, a Haig-Simons measure of income is the best measure of economic well-being.”
A similar approach can be extended to measuring the effective tax rates paid by typical nonwealthy Americans. If one is using a broad measure of income for the very wealthy, then one should use a similarly broad measure of income for the nonwealthy. This analysis considers a more comprehensive measure that includes forms of economic income that do not appear on tax returns, including tax-free employee benefits; unrealized gains on assets such as homes and retirement accounts; and, for homeowners, the value that they derive from living in the home they own.
Many typical middle-class families pay higher tax rates than the ultrawealthy
The examples below illustrate how many typical middle-class Americans pay higher tax rates than the wealthiest 400 people in the country.
The six example families considered below include workers with different incomes, assets, and family situations: some who rent their home and some who own, some who have student loans, and some with child care expenses. The analysis ascribes home and retirement account values that would be typical for families of certain income levels and assumes that those assets grow in value according to their historical averages. (see Methodology below)
The White House’s analysis examined effective rates for individual income taxes, including the net investment income tax (NIIT). The NIIT is a tax on income from wealth that essentially parallels the Medicare tax that workers pay on their wages. The White House analysis did not include the Social Security tax, but that tax is negligible for the Forbes 400 because it only applies up to an annual wage limit ($142,800 this year). To calculate effective tax rates for middle-class taxpayers in a similar manner, this analysis includes income taxes and the payroll taxes that workers pay directly—in other words, the employee side of Social Security and Medicare taxes. The analysis does not include taxes that would need to be imputed to individuals, including corporate taxes or the employer half of payroll taxes. The former is typically assumed to be borne predominantly by owners of capital, and the latter is assumed to be borne entirely by workers. (see Methodology) This analysis also does not incorporate state and local taxes, which most often fall heavier on low- and middle-income people than on high-income people.
These tax calculations are based on the tax code as it existed in 2018—the last year covered by the Forbes 400 analysis. In 2018, the tax code was essentially the same for families as the tax code that will exist again in 2022 unless Congress adopts proposals in President Joe Biden’s Build Back Better plan. Those proposals include permanently extending tax cuts for families that the American Rescue Plan Act put in place temporarily for 2021 as well as tax increases on wealthy individuals.
When federal income and employee payroll taxes are considered, each of these individuals and families pays a higher tax rate than the average member of the Forbes 400. (see Table 1)
Example 1: A single, first-year teacher with no children
This first-year public school teacher earns the average starting salary of $40,154 per year, with typical fringe benefits for teachers. She rents her apartment and pays $2,400 per year in student loan interest. She claims the standard deduction and a deduction for student loan interest. Her personal tax rate is 11.7 percent, including 5.7 percent in income taxes and 6.0 percent in employee payroll taxes.
Example 2: A couple who both earn around the median wage, rent their home, and have no children
Both partners earn $40,000 per year—a wage that would be typical for a clerk or an auto mechanic—and have workplace health coverage. They rent their home and do not have children. On their taxes, they claim the standard deduction. Their personal tax rate is 12.3 percent, including 6.2 percent in income taxes and 6.1 percent in employee payroll taxes.
Example 3: A couple who both earn around the median wage, rent their home, and have one young child
This couple also earns a total of $80,000 per year in wage income, with workplace health and retirement benefits. They had roughly $49,000 of retirement savings at the beginning of 2018. They claim the standard deduction, the child tax credit, and the maximum tax credit for child care. Their personal tax rate is 9.1 percent, including 3.2 percent in income taxes and 5.8 percent in employee payroll taxes. (Numbers do not sum due to rounding.)
Example 4: A typical working family with two children
This couple has two children, ages 13 and 16. They earn a total of $100,000 in wage income per year, with employee health and retirement benefits. At the beginning of the year, they had retirement savings of nearly $62,000, and the home they own was worth roughly $236,000. They claim the standard deduction and the child tax credit. Their personal tax rate is 8.6 percent, including 3.1 percent in income taxes and 5.5 percent in employee payroll taxes.
Example 5: An upper-middle-class working family with two children
This couple has a 10-year-old and a 13-year-old. They earn a total of $150,000 in wage income per year, with employee health and retirement benefits. At the beginning of the year, they had retirement savings of about $137,000, and the home they own was worth almost $318,000. They claim the standard deduction, the child tax credit, and the maximum tax credit for child care for their 10-year-old. Their personal tax rate is 12.2 percent, including 6.6 percent in income taxes and 5.6 percent in employee payroll taxes.
Example 6: A high-income working family with two children
This couple also has a 10-year-old and a 13-year-old. They earn a total of $200,000 in wage income per year, with employee health and retirement benefits. At the beginning of the year, they had more than $182,000 of retirement savings, and their home was worth nearly $424,000. They claim the standard deduction, the child tax credit, and the maximum tax credit for child care for their younger child. Their personal tax rate is 14.6 percent, including 9.0 percent in income taxes and 5.6 percent in employee payroll taxes.
Table 1
While these are typical families, there is no average or median family, and families’ financial circumstances vary widely. Families with children pay lower tax rates than those without children, all else being equal. Retirees generally pay lower taxes mainly because they have less income, do not pay payroll taxes, and do not pay tax on most Social Security benefits. The workers in the examples above have employer-provided health and retirement benefits, lowering their effective tax rates, but many families do not. For families with similar total incomes, those that have more income from wealth—whether from homes or financial assets—pay lower tax rates. As many researchers have emphasized, the tax code’s favorable treatment of income from wealth exacerbates racial disparities, given that on average, white families have much greater wealth than Black and Hispanic families.
Therefore, the example families are not intended to be representative of all middle-income taxpayers. But they illustrate how the current tax system favors the ultrawealthy. The federal tax system is generally progressive, and the overall U.S. tax system, including state and local taxes, is mildly progressive. But the White House study illustrates how that progressivity falls off at the very top—so much so that the richest Americans pay lower effective tax rates on their true income than many typical middle-class families.
The Build Back Better agenda would address these inequities by reforming capital gains taxes and providing tax cuts to families
The Build Back Better bill now pending in the House of Representatives takes many important steps toward a fairer tax code. Millionaires’ tax rates would rise by 7.1 percentage points on average, according to the Joint Committee on Taxation; this estimate does not count unrealized gains toward income. If policymakers want to ensure that the wealthiest Americans pay significantly more, they must reform the capital gains tax base to prevent the massive gains of the wealthiest Americans from escaping income tax.
President Biden proposes in Build Back Better to tax unrealized gains when an asset is gifted or bequeathed to heirs. Two other options are also under consideration in Congress to ensure that ultrawealthy Americans pay taxes on their large unrealized capital gains. Congress could: 1) tax the gains of ultrawealthy people as they accrue, not only when they are realized, through what is known as “mark to market” taxation; or 2) repeal stepped-up basis and move to carryover basis, where no tax is due when an asset is handed down between generations but the original owner’s gain is taxed when an heir sells the asset. President Biden’s plan and the House’s Build Back Better legislation also raise the top rate on capital gains.
President Biden’s plan and the House bill would also give substantial tax cuts to middle-class families, especially those with children. Because of the American Rescue Plan Act, three of the four example families with children would receive a greatly expanded child tax credit (CTC) in 2021. Families will receive a $3,600 credit for each child under age 6 ($1,600 larger than in previous years) and $3,000 for children ages 6 to 16 ($1,000 larger than in previous years). Seventeen-year-olds are newly eligible for the CTC, and their families will receive $3,000. The fourth example family with children—the one with the highest income—would receive a small CTC increase. The families with children would also see a much greater child and dependent care tax credit (CDCTC) for child care expenses for children under age 13. The American Rescue Plan Act changes the CDCTC from a maximum of $600 per child for middle-class families to a maximum of $4,000 per child, with the credit phasing down above $125,000 of income. Those changes expire after this year, but the Build Back Better plan and the pending House bill would extend the American Rescue Plan Act’s CTC changes through 2025 and make its CDCTC changes permanent. They also would enact permanent major tax cuts for low-income families: full CTC and CDCTC refundability and an expanded earned income tax credit for workers not raising children in their homes. The House Build Back Better bill also includes other tax cuts for families, including a refundable credit for retirement savings.
Conclusion
The White House’s analysis of the Forbes 400 reveals how the current tax system fails to make the ultrawealthy pay their fair share, and this column has illustrated how they even pay lower personal tax rates than many middle-class families. Those with the ability to pay should pay more—and the wealthiest should pay much more, especially given the rise in income and wealth inequality in recent decades. Members of Congress have an opportunity to make major progress toward a fairer tax code in the Build Back Better bill, and they must not squander it.
Seth Hanlon is a senior fellow at the Center for American Progress. Nick Buffie is a policy analyst specializing in federal fiscal policy at the Center.
Methodology
This analysis constructs six typical tax units by reference to median or average values for relevant attributes. It uses 2018 measures of the average starting salary for teachers, median wages, median pretax cash income for various family sizes, median home value for homeowners at those income levels, median retirement account values for families at those income levels, and proportional employee benefits; in the teacher’s case, it uses the typical employer share of the average health insurance plan and the average ratio of retirement benefits to wages for public school teachers. The analysis assumes the teacher has a defined benefit pension and that the other families contribute a share of their earnings to a 401(k) plan—with contribution rates ranging from 5.5 percent to 8.45 percent—along with a 4 percent employer match. The authors assume that both spouses in the second example have average-cost individual health insurance plans and that employers pay 80 percent of their premiums. The authors assume the families in Examples 3 through 6 take out average-cost family plans from one employer, with the employer paying 68 percent of their premiums, consistent with national data for 2018. These values are taken from the Census Bureau, the Congressional Budget Office, the National Education Association, the Kaiser Family Foundation, the Federal Reserve’s Survey of Consumer Finances, and multiple surveys published by the Bureau of Labor Statistics. The 401(k) contribution rates are average for participants in 401(k) plans at the relevant earnings levels, according to data from Vanguard. To impute gains on houses, the authors used the historical annual growth in the Case-Schiller index over the past 20 years. To impute the growth rate of retirement account balances, the authors: 1) assumed a 75 percent-to-25 percent investment split between equities and bonds; 2) applied the 20-year historical average returns for S&P 500 stocks with dividends reinvested; 3) applied the 20-year historical geometric average yields for Moody’s seasoned AAA corporate bonds; and 4) deducted management fees of 0.5 percent. Gains in housing, stocks, and bond holdings were all adjusted for inflation using data from the R-CPI-U-RS (through the end of 2020) and the current-series CPI-U (from the end of 2020 through the present). To impute net rental value of owner-occupied housing, the authors used data from the Federal Reserve and the National Income and Product Accounts (NIPAs). They divided the national imputed rental value of owner-occupied housing (the value of living in the home that one owns), minus depreciation, mortgage interest, property taxes, and other homeowner-specific costs, by total owner-occupied housing wealth for 2018. (The estimate of net imputed rent can be calculated by subtracting lines 155, 158, 160, and 165 from line 154 in table 7.12 of the NIPAs.) They then multiplied that ratio by the estimated home values in the examples. They assumed the couples earning $150,000 and $200,000 were two-earner couples who each earn less than the Social Security taxable maximum, such that all their earnings would be subject to Social Security payroll taxes.
The taxes that are not included in this analysis, if imputed to individuals, would raise the effective tax rates of middle-class families and the richest families alike. According to the Tax Policy Center (TPC), the middle quintile of taxpayers pays an average of 7.8 percent of their income in payroll taxes—including both employee and employer portions—1.0 percent in corporate taxes, and 0.5 percent in excise taxes. This means the federal taxes not included in this analysis total 5.4 percent for middle-income taxpayers. The top 0.1 percent of taxpayers pay 1.1 percent in payroll taxes, 4.6 percent in corporate taxes, 0.4 percent in estate taxes, and 0.2 percent in excise taxes, so the taxes not included in this analysis total 6.3 percent for them. The TPC’s effective tax rate measures use a cash income concept, which is narrower than the comprehensive income measures applied by the Council of Economic Advisers and the Office of Management and Budget, as well as in this column.