Myth - Rich Pay Lower Tax Rate - Aren't Paying Their Fair Share

‘The Rich Really Do Pay Lower Taxes Than You” read a headline in the New York Times last fall. This astounding claim, presented in the media as fact and evidence of inequities baked into President Trump’s 2017 tax cut, came from two economists at the University of California, Berkeley. Emmanuel Saez and Gabriel Zucman asserted that 2018 was the first year in U.S. history that the average tax rate on the 400 wealthiest income earners dipped below the rates paid by the lower-middle class and poor.

Finally, we had proof the rich weren’t paying their fair share. But new data from the Internal Revenue Service suggest it isn’t true.

The Saez-Zucman analysis raised eyebrows among other economists who study tax data, in part because they claimed it reflected the first full year under the new tax rates. At the time they published their study, the IRS had yet to release the data necessary to make the calculations they described. Preliminary numbers for 2018 income-tax returns, covering all filings made by last year’s Oct. 15 extended deadline, came out only last week. These data tell a very different story: America’s wealthiest earners still carry the lion’s share of the tax burden.

Closer inspection reveals that Messrs. Saez and Zucman imputed the tax rates they claim for 2018 from records that predated the Trump tax cut, and therefore didn’t capture its effect on the measured distribution of income. They built in opaque assumptions that now appear to have exaggerated the tax cut’s benefit to high-income earners.

This wasn’t the only problem with the Saez-Zucman statistics. Their alleged 23% tax rate paid by the highest earners—encompassing all federal, state and local taxes—fell below the Congressional Budget Office’s estimates for the top income percentile’s federal tax rate alone. The two economists’ tax rates for the poor also looked suspiciously high. A 25% rate for the lowest quintile of earners would be almost twice the level found in other estimates, including those using better-established data from the Congressional Budget Office and the nonpartisan Institute on Taxation and Economic Policy. The discrepancy arose from Messrs. Saez and Zucman’s exclusion of the earned-income tax credit for low-income households, artificially inflating the amount of tax the poor really pay.

The new IRS numbers now provide reason to doubt Messrs. Saez and Zucman’s entire narrative of a regressive U.S. tax system designed to favor the rich at the expense of the poor. The IRS reports effective income-tax rates on the adjusted gross incomes of different groups of earners. That’s the percentage of income that people actually pay to the government, as distinct from the statutory tax rate.

According to the IRS, the top 0.01% of earners—those with incomes above $10 million—paid a 24.8% effective federal income-tax rate in 2018. This isn’t very different from the 25.3% the group paid in 2017, and is higher than the average rate of 22.5% on the same group during the George W. Bush administration. As these rates only encompass federal income taxes, most filers can expect to add another 8% to 12% of income from other forms of taxation, placing their total burden well above the Saez-Zucman numbers.

How does that affect the claims of regressivity? It’s true the remainder of the top 1% (those with incomes between roughly $500,000 and $10 million) paid a slightly higher effective rate, at 26.5%, than the top 0.01% did. But tax rates drop rapidly from there, with filers in the $50,000 to $75,000 reporting bracket (approximately the median U.S. family income) facing an average federal income-tax rate of 8.4%.

People who earned between $15,000 and $40,000 paid an average federal rate of merely 4% of their adjusted gross incomes in 2018. And thanks to the earned-income tax credit and others like it, the poorest earners paid very little if any federal income tax at all.

In short, the federal income-tax structure still places the unambiguous bulk of its burden on the highest earners. The Trump tax cut hasn’t changed that. In 2018, the top 1% of U.S. earners paid roughly 37% of all federal income taxes. The top 5% paid around 58%. This suggests that policy makers wishing to mitigate regressive features of the tax system should look elsewhere. State and local sales and property taxes may be a more promising area for reform.

The IRS’s preliminary data also suggests that the needle on income inequality—the motive force behind the Saez-Zucman research and the wealth-tax proposals it has been used to support—hasn’t moved lately. The share of adjusted gross income that went to the top 1% in 2018 was essentially the same as it was a decade earlier, at least going by the IRS numbers. The same is true of the top 0.1% and even the top 0.01%, the ultrarich so often targeted in political rhetoric from the left.

The full economic effects of the Trump tax cut extend beyond personal income-tax rates, and will be seen in the data only when future statistical releases become available. The corporate income-tax cut, for example, will likely prompt high earners to shift income from their personal returns to corporate returns, further lowering the measured income shares of the top 1%. Ironically, the reduction in the corporate tax rate could lead to a statistical reduction in income inequality.

In their rush to embrace a convenient political narrative last fall, much of the press and political classes never considered the possibility that the data would undermine their story. It did.

Mr. Magness is a senior research fellow at the American Institute for Economic Research. Mr. Miller is an associate professor of economics at Troy University.