Saturday, July 14, 2012

Analyzing the CBO's Report on Federal Taxes and Income

Earlier this week, the Congressional Budget Office (CBO), which is a non-partisan agency that works for the United States Congress, published a report entitled "The Distribution of Household Income and Federal Taxes, 2008 and 2009." This report is a continuation of the CBO report analyzing household income from 1977-2009, the one that made a big stink about how the income of the 1% grew tremendously in comparison to others. This report is important for many reasons, one of them being that we can better realize the effects that the recession have had both on income and the federal tax levels for economic quintiles.

The history of the American begins with a protest against unreasonable levels of taxation (e.g., no taxation without representation), and those beginnings have continued to shape the political rhetoric as to the type and extent of taxation. When looking at the findings of the CBO, let us keep these considerations in mind, as well.

The first set of findings are based off of a chart which is on the study's cover page (posted below). This chart displays the percent of before-tax income (includes any government transfers) that a given quintile has in comparison to the percent that the given quintile pays in federal taxes. Looking at this chart, you notice a few things. The lowest quintile is hardly paying anything in federal taxes. Even the second and third quintiles are hardly paying anything in comparison to their before-tax income. If we are to define "paying one's fair share" as paying a share of tax burden that is comparable to the share of one's before-tax income, then the rich are paying more than their fair share. The Heritage Foundation wasted no time to point that one out by saying the same thing. Even the economist Greg Mankiw ran the numbers and found that for every dollar earned, those in the lowest quintile receive three dollars in government transfers. Even the middle quintile is starting to become show some dependency on government, says Mankiw. The fact that nearly half of Americans don't even pay the federal income tax, which is both confirmed by Politifact and this CBO report (p. 7), is what the Right uses to fuel the debate on government dependency, although ironically enough, they are, in a sense, affirming the "class warfare" rhetoric of the Left.

Should we conclude from this that the poor don't pay their fair share? This report doesn't factor in state and local taxes. Most government spending (62%) is done on a federal level, which means that federal taxes are providing a good amount of government revenue. There are multiple state taxes. Much like the federal income tax, the state income tax is also progressive. The lower quintiles aren't going to pay the corporate tax. Property tax is assessed on the local level, and will depend not only on their rate of taxation, but the size of one's property. Consumption taxes (e.g., sales and excise) and the rate that you contribute to the state tax revenue is based on your consumption patterns. Although a bit dated, the report done by the Tax Foundation shows that even when considering state and local taxes, the burden doesn't greatly shift from federal taxes. It is thus reasonable to surmise the tax burden is a bit off-balance. 

Looking at the income data can provide ammunition for both sides. The people in the Glenn Beck camp used it to say that the 1% were the hardest by the recession. The after-income tax data provided by the CBO proves that one to be true (p. 15).

I can hardly imagine anyone on the Left crying over the one percent's loss, especially when they look at the before-tax income data provided by the CBO (p. 4). Without government transfers (e.g., Social Security, food stamps, Medicare), the average before-tax income for 2009 was $7,600 for those in the lowest quintile. With government transfers, it bounces up to $30,500. The Left can use that to claim that without such government programs, the poor would be even more destitute. I discussed previously how to target the root causes of poverty, something which might be of interest to those on the Left because these programs have this unfortunate propensity to perpetuate poverty, not alleviate it. Another point I would like to make is that although the top one percent saw a much larger increase in income than everyone else (probably has something to do with globalization and the technological advances we've seen since 1979), notice how the income has still gone up for everyone over the years in real dollars. That's only based on income. I can only imagine what the progress made over time would look like if we considered the quality and quantity of consumption, as well. 

Finally, there is the matter of taxes being at a thirty-year low (p. 14). I find the CBO's chart [below] to be comforting because it should be no surprise that I find lower tax rates to be better. 

Some on the Left disagree because this means less government revenue to continue programs they [inaccurately] view as successes. My former economics professor even took an opportunity to point out that there is no correlation between the tax rate and GDP growth. If there's no relation between tax rate and GDP growth, let me also point out in kind that raising the marginal tax rate on the rich isn't going to make things better, either. I created a scatter plot (see below) between the top tax rate and tax revenue as a percent of GDP (overlapping data dates back to 1933). I chose the top tax rate because it affects "the 1%," and I went with tax revenue as a percent of GDP because it interacts with the other variables that consist of the GDP (i.e., consumption, investment, trade balance, government spending). What I found is that the coefficient of determination is roughly 0.04, which means that the correlation is very low. Even so, whatever correlation does exist is actually pointing in the opposite direction that the Left would want it to be. If the relation between the two variables is almost non-existent, it is better that the government keeps the tax rate lower so it doesn't violate that wonderful libertarian axiom of nonaggression.

What can we conclude from all of this? It's one big, complicated mess. I'd say life would be a lot easier if the government did less and the tax code were simplified. Short of that, I expect the rhetoric on taxation to be "politics as usual."


  1. Thanks for sharing this analysis! i was looking for so long to find the best one! Tax Letters

    1. Thank you kindly for the compliment!