Personal incomes and average tax rates on Americans’ incomes have both been climbing, especially at the highest earnings levels, according to the Internal Revenue Service (IRS).
The latest IRS data on individual income taxes come from calendar year 2006. The economy was still healthy and growing, increasing individual income tax collections along with overall average effective tax rates.
The data show both the income share earned by the top 1 percent of tax returns and the tax share paid by that top 1 percent have once again reached all-time highs—and once again those individuals’ tax burden is much higher than their income share.
In 2006, the top 1 percent of tax returns paid 39.9 percent of all federal individual income taxes and earned 22.1 percent of adjusted gross income (AGI). Both figures are significantly higher than in 2004, when the top 1 percent earned 19 percent of AGI and paid 36.9 percent of federal individual income taxes.
All Boats Lifted
The IRS data show increases in individual income across all income groups (Table 1). Just as the highest earners lost the biggest percentage of their incomes during the recession of 2001, so have they prospered the most as the economy continued to rebound through 2006.
From 2000 to 2002, the AGI of the top 1 percent of tax returns fell by more than 26 percent. In that same period, the AGI of the bottom 50 percent of tax returns increased by 4.3 percent.
Since 2002, however, as the recession ended, AGI has risen by more than 81 percent for the top 1 percent (an average of more than 20 percent per year) and 17 percent (an average of around 4 percent per year) for the bottom 50 percent.
Top Earners Gain Most
Overall, between 2000 and 2006, pre-tax income for the top 1 percent of tax returns grew by 34 percent, while pre-tax income for the bottom 50 percent increased by 22 percent. All figures are nominal (not adjusted for inflation).
This pattern of income loss and growth at the top of the income spectrum is the same during every recession and recovery. The net result has been a sharp rise in federal government tax revenue from 2003 to 2006 compared to previous years.
The IRS data in Table 2 include all of the 135.7 million tax returns filed in 2006 that had a positive AGI, not just the returns from people who earned enough to owe taxes. From other IRS data we can see 92.7 million tax returns in 2006 came from people who paid taxes into the Treasury.
43 Million Pay Nothing
That leaves 43 million tax returns filed by people with positive AGI who used exemptions, deductions, and tax credits to completely wipe out their federal income tax liability.
Not only did they get back every dollar the federal government withheld from their paychecks during 2005, many received additional money back from the IRS, as a result of refundable tax credits such as the Earned Income Tax Credit, which are not included in the aggregate percentile data here.
Including all tax returns that had a positive AGI, taxpayers with an AGI of $153,542 or more in 2006 constituted the nation’s top 5 percent of earners. To break into the top 1 percent, a tax return had to have an AGI of $388,806 or more.
These numbers are up significantly from 2003, when the equivalent thresholds were $130,080 and $295,495.
Top incomes in 2006 are also above the peak they reached in 2000. At the height of the boom and bubble, $313,469 was the threshold to break into the top 1 percent, and then it fell to $285,424 in 2002 but recovered fully in 2005.
Huge Burden on Top Earners
The top-earning 25 percent of taxpayers (AGI more than $64,702) earned 68.2 percent of the nation’s income and paid more than four of every five dollars collected by the federal income tax (86.3 percent). The top 1 percent of taxpayers (AGI over $388,806) earned approximately 22.1 percent of the nation’s income (as defined by AGI), yet paid 39.9 percent of all federal income taxes.
That means the top 1 percent of tax returns paid about the same amount of federal individual income taxes as the bottom 95 percent of tax returns.
Average tax rates increased once again in 2006 as the economy continued to grow, even though there were no significant pieces of tax legislation enacted in 2006. Overall, the average tax rate for returns with a positive liability increased from 12.1 percent to 12.45 percent from 2004 to 2005 and then up to 12.60 percent for 2006, not including any refundable credits.
The 2003 tax cut was the second in three years, and although tax rates are lower, the federal income tax still remains highly progressive, which means rates go up rapidly as personal income rises. The average tax rate in 2006 ranges from 3.0 percent of income for the bottom half of tax returns to 22.8 percent for the top 1 percent.
Gerald Prante ([email protected]) is a senior economist at the Tax Foundation in Washington, DC. An earlier version of this article appeared July 18 in Fiscal Fact No. 135. Used with permission.