Thursday, January 19, 2012

Five Observations about Progressivity

There has been a lot of discussion recently about tax progressivity.  A few observations on the topic:

1. The U.S. personal income tax is generally progressive, and substantially so.  Click here to see the numbers.  The average tax rate for tax returns with over $1 million in income is 25 percent.  The average tax rate for returns with income between $50,000 and $75,000 is 7 percent.

2. It is arguably better to use an average tax rate that is all-inclusive.  That is, we should include not only personal income taxes but also payroll and corporate income taxes.  CBO analysts regularly do that.  They find a substantially progressive tax system, as I have pointed out before.

3. If we added transfer payments (which are essentially negative taxes), we would find an even more progressive fiscal system.  Those data are harder to come by, as data on transfers are rarely integrated with data on taxes.

4. It make little sense to aggregate payroll taxes with personal income taxes and ignore corporate income taxes.  A corollary: Paul Krugman should be more careful when reproducing graphs from partisan think tanks.

5. All of these calculations are static.  They ignore the general-equilibrium effects that arise as the true burden of taxation is shifted by behavioral responses.  In essence, these calculations are made under the implicit assumption that factors of production are supplied inelastically, so the tax stays where legislators put it.  Of course, that assumption is implausible, especially in the long run.  True general-equilibrium tax incidence is very hard, and as far as I know, reliable estimates on it are not readily available.

Update: Oddly, rather than admitting an oversight, Paul Krugman continues with the same misleading claims in his column in Friday's paper.  Even more oddly, at his blog, he uses the tax-shift argument (my point 5 above) to justify the exclusion of the corporate tax.  Of course, tax shifting because of behavioral responses applies to all taxes, not just corporate taxes.  The implication of tax-shifting is not that one should just ignore corporate taxes, as Paul chooses to do, but rather that all static analyses of the distribution of the tax burden should be taken with a grain or two of salt.