How Progressive is the U.S. Federal Tax System? A Historical and International Perspective

O ver the last 40 years, the U.S. federal tax system has undergone three striking changes, each of which seems to move the federal tax system in the direction of less progressivity. First, there has been a dramatic decline in top marginal individual income tax rates. In the early 1960s, the statutory individual income tax rate applied to the marginal dollar of the highest incomes was 91 percent. This marginal tax rate on the highest incomes declined to 28 percent by 1988, increased significantly to 39.6 percent in 1993, and fell to 35 percent as of 2003. Second, corporate income taxes as a fraction of gross domestic product have fallen by half, from around 3.5–4.0 percent of GDP in the early 1960s to less than 2 percent of GDP in the early 2000s (for example, Auerbach, 2006). Meanwhile, corporate profits as a share of GDP have not declined over the period, suggesting that capital owners—who are disproportionately of above-average incomes—earn relatively more net of taxes today than in the 1960s. Third, there has been a substantial increase in payroll tax rates financing Social Security retirement benefits and Medicare. The combined employee–employer payroll tax rate on labor income has increased from 6 percent in the early 1960s to over 15 percent in the 1990s and 2000s. Moreover, the Social Security payroll tax applies only up to a cap—equal to $90,000 of annual earnings in 2005—and is therefore a relatively smaller tax burden as incomes rise above the cap. However, the conclusion that these three changes have reduced the progressivity of the federal tax system is less obvious than it may at first appear. For example, in the case of the individual income tax, the numerous deductions and