Integrating the tax burdens of the federal income and payroll taxes on labor income.

"The [Social Security] tax is the neglected stepchild of tax policy analysis." (1)

I. INTRODUCTION

When politicians, or even the average guy on the street, debate whether the allocation of the federal tax burden is "fair" and "efficient," they typically do so by talking only about the federal income tax burden. For example, columnist Jerry Heaster, correctly reporting that the top one percent of income earners in 1999 paid about thirty-six percent of "all federal personal income taxes," writes, "How much tax do high income Americans need to pay before the class warriors will be satisfied?" (2)

But the fact of the matter is that about as much federal revenue is collected from the payroll taxes (Social Security and Medicare) as from the personal income tax, (3) and the payroll taxes are extremely regressive, significantly diluting the percentage of the total federal tax burden paid by the wealthy. For example, in a year 2000 study, the staff of the Joint Committee on Taxation estimated that, under the law at that time, those earning more than $200,000 would pay 42.7% of the total federal personal income tax collected, while the top 1% would pay 33.6%. (4) If, however, all federal taxes are measured, including the regressive Social Security and Medicare taxes, the shares plummet to 27.5% for those earning more than $200,000 and 18.6% for the top 1%. (5) These reductions will become even more dramatic after the full phase-in of the 2001 tax cuts for the super wealthy. (6)

While the tax debate centers on the federal income tax burden, provocative empirical studies published by economists Andrew Mitrusi and James Poterba in 2000 show that nearly two-thirds of American households now pay more in federal payroll taxes than income taxes, (7) chiefly because of significant increases in the payroll tax burden over the last twenty years. This results in much higher effective tax rates, as well as a higher total tax burden, for the lower and middle classes than is probably widely appreciated. Further, it results in a higher portion of the federal tax burden being borne by labor income (as opposed to capital income, which is concentrated in the wealthier households) than is probably widely appreciated. In other words, there is a huge elephant in the room that few politicians talk about and even fewer citizens recognize.