In an earlier post I showed a chart that attempted to convey the limited progressivity of the American tax system when not only federal taxes but also state and local ones are taken into account. Here are two additional charts. They’re based on my calculations from data for 2004 in a Tax Foundation report (tables 3 and 4 and figure 1) by Andrew Chamberlain and Gerald Prante.
These charts show effective tax rates for each of the five quintiles of households. The effective tax rate is calculated as taxes paid divided by income. For instance, to get the effective rate for the bottom quintile, I divide the average amount paid in taxes by households in that quintile by the average income of those households.
It turns out that whether taxes are progressive depends on how income is defined.
As the first chart shows, if income is measured as market income — income from employment, investments, and a few other sources, but not including government transfers — the tax system is essentially flat. The effective tax rate is approximately 30% for households throughout the income distribution. This may hide some progressivity, since the effective rate may be higher in the top portion of the top quintile, but we can’t be sure because the Tax Foundation data don’t separate out the top 1% or 0.1% of households.
Adding government transfers (as the Congressional Budget Office does in its calculations of federal tax progressivity) increases the average income in each quintile, but much more for the bottom than for the middle or top. This reduces the effective tax rate more in the lower part of the distribution than the upper, resulting in a progressive structure.
What should we conclude? I think the first chart here better reflects the impact of the U.S. tax system. It does very little to alter the market distribution of income. Redistribution is achieved mainly by government transfers rather than by taxes. We aren’t unusual in this respect, though; it’s the case in most if not all rich countries.