Effective Tax Rates: A Critical Look at a New Study 271

 in IRS News  tagged Effective Tax Rates / income by (updated 88 days ago)

Despite claims that the wealthy pay lower effective tax rates (ETRs) than other Americans, a new analysis of a recent study by Berkeley economists suggests otherwise. The study, which claims the wealthiest Americans’ ETRs have dropped since the 2017 Tax Cuts and Jobs Act (TCJA), is criticized for its flawed methodology and narrow window of analysis.

Flawed Methodology Skews Results 🤯

The Berkeley study’s central flaw lies in its expansive and unconventional definition of “economic income.” Instead of using taxable income, the authors include the unrealized book profits of businesses owned by the wealthiest individuals. This approach significantly inflates the income of the top 400 richest Americans and, consequently, makes their ETR appear artificially low.

The Problem with Unrealized Profits

  • Corporate profits only become taxable to shareholders when they’re distributed as dividends or realized as capital gains from selling shares. A large portion of these profits is often reinvested to fuel company growth.
  • The study misleadingly matches these theoretical, unrealized profits with the taxes actually paid in a given year, creating a skewed ratio that suggests a lower ETR.
  • A separate analysis by David Splinter, an economist at the Joint Committee on Taxation, corrects for these and other issues, finding a completely different result. Splinter’s analysis shows the top 400’s ETR is 13 percentage points higher than the rest of the population’s (38% vs. 25%) during the same period.

Narrow and Tainted Window of Analysis 🔬

The study’s inclusion of the pandemic year 2020 further taints its findings. This year, marked by massive business losses, is not representative of typical economic conditions.

  • The study’s results are unlikely to hold if extended beyond 2020, as both federal and corporate tax revenues rebounded strongly in the years that followed.
  • The study also points to the TCJA’s bonus depreciation provision, which allows companies to immediately expense investments, as a reason for reduced taxable income. However, this provision simply shifts deductions forward in time and is a temporary effect, not a permanent reduction in ETRs.

 

US ETRs Are High and Progressive Relative to Peers 📈

 

While the Berkeley study suggests otherwise, other data shows the US tax code is highly progressive.

  • The US federal tax code is highly progressive, and its progressivity has increased over time, even since the TCJA.
  • According to the Congressional Budget Office (CBO), the top 1% of earners had an ETR of 29.8% in 2021, compared to 17.4% for the population as a whole.
  • Low-income households have seen their ETRs trend downward, particularly due to increasingly generous refundable tax credits like the earned income tax credit and the child credit. In 2021, pandemic relief programs even resulted in a negative ETR of -22.9% for the bottom 20% of households.
  • Compared to many European countries, the US has higher taxes on capital income. For example, the US capital gains tax rate is about 10 percentage points higher than the average among OECD and select EU countries.

In short, standard analyses confirm that US tax rates are progressive and competitive on the global stage, despite the claims of the Berkeley study. The TCJA made the US more attractive to mobile capital, and the economy has reaped the benefits.

Leave a comment

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

271 thoughts on “Effective Tax Rates: A Critical Look at a New Study”