Assistant Professor Daniel Hemel on taxes paid by the highest earners in the United States:
The IRS released data this week on the 400 individual income tax returns with the highest adjusted gross incomes (AGIs). According to the IRS data, the average federal income tax rate for the top 400 was 22.9% in 2013, down from a peak of 29.9% in 1995 (though up from a low of 16.6% in 2007). Much has been written about the IRS data already (and no doubt more will be written in the coming days and weeks), but three trends deserve more attention than they have drawn thus far.
First, and most remarkably, charitable contributions by taxpayers in the top 400 have increased dramatically since the mid-1990s—both in absolute dollar terms and as a percentage of income. In 1995, the average taxpayer in the top 400 reported charitable contribution deductions of $2.9 million, slightly less than 5.6% of AGI. In 2013, that number was $32.8 million—more than 12.1% of AGI. That fact alone explains a sizeable share of the decline in the average tax rate of the top 400. Assuming that charitable contribution deductions offset income that otherwise would have been taxed at the top marginal rate, then charitable deductions reduced the average tax rate of those in the top 400 by 2.2 percentage points in 1995 and by 4.8 percentage points in 2013. If so, then 37% of the decline in the average tax rate of the top 400 (i.e., 2.6 percentage points) would be attributable to the increase in charitable contribution deductions.
Second, deductions for taxes paid to state and local governments (as well as taxes paid to foreign governments for which no foreign tax credit was claimed) rose from 5.2% of AGI for the top 400 in 1995 to 7.8% of AGI in 2013. Some of this increase might be explained by the fact that taxpayers have had the option of deducting state and local sales taxes in lieu of income taxes since 2004; however, the available data suggests that the 2004 change made at most a minor difference for the top 400. (The taxes-paid deduction as a percentage of AGI for the top 400 barely budged when the change in law went into effect—from slightly more than 4.0% in 2003 to slightly less than 4.1% in 2004.) More likely, the rise in taxes paid reflects the rise in state income tax rates: California’s top rate rose from 11% in 1995 to 13.3% in 2013, and New York’s top rate rose from 7.5% in 1995 to 8.82% in 2013. And assuming that taxes-paid deductions offset income that otherwise would have been taxed at the top marginal rate, then 14% of the decline in the average tax rate of the top 400 (i.e., 1 percentage point) would be attributable to the increase in taxes-paid deductions. (Those in the top 400 who are subject to the alternative minimum tax wouldn't be able to utilize the taxes-paid deduction, but the AMT affects very few among the very rich: only 2.4% of income taxes paid by the top 400 comes through the AMT.)
Third, foreign tax credits claimed by the top 400 increased from less than 0.7% of AGI in 1995 to nearly 1.2% of AGI in 2013. The increase in foreign tax credits claimed explains roughly 8% of the decline in the average tax rate of the top 400 between 1995 and 2013 (more than 0.5 percentage points). If foreign tax credits claimed reflect foreign taxes actually paid, and if the taxes-paid deduction also reflects state and local taxes actually paid, then taxes paid by the top 400 to all governments (federal, state, local, and foreign) amounted to 35.8% of AGI in 1995 and 31.9% of AGI in 2013. On those assumptions, total taxes paid by the top 400 fell by 3.9 percentage points from 1995 to 2013—still a substantial decline, but much less than 7 percentage point drop that one sees when one focuses exclusively on federal income taxes.
These calculations are, concededly, crude. The IRS data shows deductions and credits claimed by the top 400 for taxes paid to state, local, and foreign governments; the data does not show actual taxes paid to those governments. (It omits, for instance, state and local sales taxes paid by individuals who elected to deduct state and local income taxes.) Moreover, a number of the above calculations assume that the marginal tax rate for all those in the top 400 is 39.6%; however, the IRS data indicates that some in the top 400 actually face a lower marginal rate (likely because their income primarily consists of dividends and capital gains taxed preferentially). Finally, none of this is to deny that the very rich paid less in taxes as a percentage of income in 2013 than they paid in 1995. What it does suggest is that a singular focus on federal income taxes as a percentage of AGI may miss part of the picture: the very rich appear to be giving much more to charity—and paying more in taxes to state, local, and foreign governments—now than they did two decades ago.