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CASE STUDY

HOW. THE TAX BURDEN IS DISTRIBUTED

Much debate over tax policy concerns whether the wealthy pay their fair share. There is no objective way to make this judgment. In evaluating the issue for yourself, however, it is useful to know how much , families with different incomes pay under the current tax system.

Table 8 presents some dab on how all federal taxes are distributed among income classes. To construct this table, families are ranked according to their income and placed into five groups of equal size, called quintiles. The table also presents data on the richest one percent of Americans. The second column of the table shows the average income of each group. The poorest one-fifth of families had average income of \$14,900, and the richest one-fifth had average income of \$182,700. The richest one percent had average income of just over \$1 million.

TABLE 8 The Burden of Federal Taxes

The fourth and fifth columns compare the distribution of income and the distribution of taxes. The poorest Quintilian earns 4.2 percent of all income and pays 1.1 percent of all taxes. The richest Quintilian earns 52.4 percent of all income and pays 64.3 percent of all taxes. The richest one percent (which, remember, is 1120 the size of each Quintilian) earns 14.8 percent of all income and pays 21.5 percent of all taxes.

Tins table on taxes is a good starting point for understanding the burden of government, but the picture it offers is incomplete. Although it includes all the taxes that flow from households to the federal government, it fails to include the transfer payments, such as Social Security and welfare, that flow from the federal government back to households.

Studies that include both taxes and transfers show more progressive. The richest group of families still pays about one-quarter of its income to the government, even after transfers are subtracted. By contrast, poor families typically receive more in transfers than they pay in taxes. The average tax rate of the poorest quintile, rather than being 5.5 percent as in the table, is approximately negative 30 percent. ~ other words, their income is about 30 percent higher than it would be without government taxes and transfers. The lesson is clear: To understand fully the progressive of government policies, one must take account of both what people pay and what they receive.

Horizontal Equity If taxes are based on ability to pay, then similar taxpayers should pay similar amounts of taxes. But what determines if two taxpayers are similar? Families differ in many ways. To evaluate whether a tax code IS horizontally equitable, one must determine which differences are relevant for a family’s ability to pay and which differences are not.

Suppose the Smith and Jones families each have income of \$50,000. The Smiths have no children, but Mr. Smith has an illness that causes medical expenses of \$20,000. The Jones  are in good health, but they, have four children. Two of the Jones children are in college, generating tuition bills of \$30,000. Would i be fair for these two families to pay the same tax because they have the same income'[ Would it be more fair to give the Smiths a tax break to help them offset their high medical expenses? Would it be more fain to give the Jones  a tax break to help them with their tuition expenses.