Tax myths versus reality: Corporations, individuals, income and benefits
INSIGHT ARTICLE |
Americans have a wide range of opinions when it comes to taxes. There are scores of major proposals supposedly designed to make our system simpler, more equitable or more conducive to economic growth. Equity and fairness, of course, are highly subjective concepts. Regardless of where you may want to end up, it is important to have a solid grasp of the facts as they really are. You may be surprised at how little many of us know about the distribution of income and taxes in the American economy. Here are a few areas where misunderstandings are common.
Corporations vs. individuals
It is common to hear arguments that wealthy and powerful corporations are making most of the income in America and paying little or no taxes.
In fact, corporations are responsible for only a small fraction of the income earned in our economy. Individuals and corporations combined reported approximately $11 trillion of income potentially subject to tax in 2012. Corporations accounted for about 13 percent of that income, while individuals accounted for 87 percent. Interestingly, although they represented only 13 percent of this measure of total income, corporations paid 18 percent of the combined total of all individual and corporate taxes.
Individuals: wealth, capital and income
On the individual side, some argue that the vast bulk of the income in America goes to the wealthy as income from stocks, bonds and other investments. Official statistics of income show that reality is quite different.
The vast bulk of American income comes from work, not from business or investments. Furthermore, the income Americans earn from wages, salaries and retirement pensions is predominantly earned by individuals in the broadly defined middle or upper-middle class, those earning between $50,000 and $500,000 ($500,000 is commonly thought of as the lower bound of the so-called top 1 percent).
The richest one percent are very affluent as individuals but as a group are responsible for only 20 percent of the income generated by the economy. Therefore, some experts have concluded that even very substantial tax increases on the very richest Americans would not generate enough tax revenue to change the country’s overall patterns of income distribution, even if the additional tax revenues were redistributed in cash solely to the bottom 20 percent.
Income taxes: What are the real tax rates?
There is much talk about tax fairness and inequality, particularly related to the income tax. On average, however, most people would be surprised to see how progressive the system really is, particularly after major tax hikes on upper-income Americans were enacted in early 2013.
As shown in the graphic, in 2013, the top 1 percent of individuals (those with incomes above $500,000) paid income taxes of around 25 percent to 30 percent of their incomes. Those with incomes under $100,000 paid under 10 percent. The top 1 percent paid taxes at more than twice the rate of those with more modest incomes. Reasonable people can say this is not progressive enough, but the rich are not paying taxes at a lower rate than taxpayers with middle or moderate incomes.
What about Social Security taxes?
Many people think that it is not enough to talk about income taxes, since many lower-income Americans pay more in Social Security taxes than they do in income taxes. Those too should count as taxes, they argue.
But others argue that payroll taxes should not be viewed as taxes at all, but as if they were a special type of mandatory insurance premiums or mandatory contributions to a retirement plan that entitle those who paid them to specific retirement or medical benefits in retirement. This group argues that Congress has a moral obligation not to reduce the benefits they have paid for in this manner, just as no commercial insurance company could renege on its promises.
How accurate is it to say that Americans have paid for their Social Security and Medicare benefits through their payroll taxes?
The Urban Institute has done extensive studies that show otherwise. In the typical case, Americans do come close to paying for their Social Security benefits, and some pay more than they receive. However, Medicare taxes paid by individuals and their employers, and the earnings on those amounts while they are on deposit in government trust funds, only pay for about 25 percent of the Medicare benefits individuals receive. This is more than a temporary problem, as it might be if we were looking only at the beneficiaries who retired in the 1970s, 1980s or 1990s. There was no way these individuals could have fully contributed during their working lives to a program that was only created in 1965.
These charts illustrate that the substantial Medicare shortfall exists even for people who have been contributing Medicare taxes their entire working lives, which is why some observers from different points of view argue that the current system is unsustainable.