Taxes Take Roller-Coaster Ride

In last decade, cuts, reform, and an escalation in Social Security have shifted tax burdens

PICTURE the owner of a successful small business and his or her spouse, say, an associate in a large law firm. Together, they earn $206,162 and pay $55,045 in federal taxes - 26.7 percent of their income.

This puts them at the current average for the top-earning 5 percent of American families.

Now reel back to their counterparts a decade ago, the debut of the Reagan era.

Such families averaged 32 percent less income - not counting inflation - and paid about 10 percent higher tax rates.

A reduced tax burden is the good news for today's family, and the Reagan income tax cuts of 1981 can take much of the credit. Social Security taxes

Overall, the federal tax bite for all households has barely changed from 10 years ago: The total is 1 percent smaller, according to the House Ways and Means Committee. Increases in state and local taxes have more than made up the difference.

But the relief felt at the top of the income scale has come at the expense of those at the bottom, especially the lowest-paid 20 percent of taxpaying families.

The average 1990 income for this group of American families is forecast at $7,725, 3 percent lower than 10 years ago, once inflation is figured in. Yet the 9.7 percent average federal tax rate for such families is more than 16 percent higher than it was.

For this, they can thank the rising Social Security payroll tax.

Taxes have undergone significant changes in the past decade: cuts in 1981; reform in 1986; and, less noted but just as significant, a 1983 agreement to escalate Social Security taxes.

The federal tax code is still progressive; the poor pay a smaller share of their income than the rich. But the system is less progressive than when the decade began, according to the Congressional Budget Office, which works at the behest of the Democrats who run Congress.

The Bush administration counters that because incomes rose among the wealthy much faster than their tax rates fell, the top income levels now pay a larger portion of all federal taxes than they did in 1980.

One decidedly progressive move in the federal system: Nearly 14.5 million families will pay no taxes at all for 1990, most of them with less than $10,000 in income. This group was expanded in the 1986 tax reform.

The boon to the wealthy in the 1980s has been the shift in federal taxes from the traditional income tax to the highly regressive Social Security tax. Because Social Security taxes are deducted automatically from paychecks, taxpayers are not nearly as conscious of them as they are of the traditional federal income tax, which often requires an extra check from taxpayers by April 15.

Yet Social Security has grown to the point that a quarter of American households now pay more on the payroll tax - not counting the employers' contribution - than they pay in income tax. Throw in the employers' contribution, and 55 percent of households put more into Social Security than they pay for all the rest of the federal government.

For the median household of four, with two wage earners and $49,326 in income in 1989, the federal income tax rate fell from 13.7 percent in 1980 to 12.5 percent, according to the Tax Foundation. The Social Security tax rose from 6.1 percent to 7.5 percent. State, local tax burdens jump

The Social Security tax is regressive by design, targeted at working people. It taxes only the first $51,300 of income, then stops. It taxes only paycheck earnings, not capital gains. No standard deduction or exclusion softens its effect on lower incomes.

The way the tax burden is shared has swung back and forth in the 1980s. The burden shifted most heavily toward the poor between 1980 and 1985. Since the 1986 tax reform, the burden has shifted roughly halfway back toward the wealthy.

Overall, taxes fell and rose again in the 1980s. Federal taxes peaked in 1981, according to the Tax Foundation's figures, and dropped about 10 percent to 1985. Since then, the rise of Social Security has boosted them back to the 1980 level.

Federal taxes are only part of the story. When state and local taxes are added, it becomes clear that the 1980s carried on the march to ever-higher taxes.

State and local tax burdens vary wildly. States such as Florida and New Hampshire, for example, have no state income taxes. According to the US Census Bureau, which assesses the share of all taxes that go to each level of government, while federal tax burden overall is about at the 1980 level, the federal take of all tax revenue shrunk from 61 percent then to 56 percent in 1988.

The state share of all taxes grew from 24 to 27 percent, and local government from 15 to 17.

These figures would very roughly indicate that nationwide the tax burden imposed by states and localities has grown by more than 10 percent each.

One of the most controversial quirks of the post-reform tax code is the ``bubble.'' The marginal rate - that is, the rate paid on the last dollars earned - is 33 percent for married couples earning between $78,401 and $185,730. Above that income level, the marginal rate drops to 28 percent.

The rationale is that no one is supposed to pay more than 28 percent of his or her total income in federal income tax. Those affluent ``bubble'' families can exclude part of their income from taxes, so the 33 percent marginal rate is an equalizing measure. The very highest incomes pay the 28 percent rate, at least theoretically, on all their money. Proposals for the future

The tax guru of Capitol Hill, House Ways and Means Committee chairman Dan Rostenkowski (D) of Illinois, has proposed extending the 33 percent bubble up the income scale, meaning the wealthiest Americans would pay at a higher overall rate. He also proposes increases in cigarette, alcohol, and gasoline taxes.

Sen. Daniel Patrick Moynihan (D) of New York has proposed rolling back Social Security taxes, and the administration has proposed restoring a lower rate for capital-gains income - mainly stocks, bonds, and real estate.

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