Yet, a new report shows, more than a third of the U.S. middle class get more in government benefits than they pay in taxes, and that share is rising. The middle class has clearly not been forgotten by tax policy.
So how did such a gulf open between popular perceptions of middle-class taxation and the reality painted by the data? It has to do with the forces that are conspiring to drive middle-class taxes down and middle-class benefits up.
Not so long ago, the popular perception had firmer ground in reality. Coming out of the Vietnam War era, the middle class really did pay a substantial share of taxes and reap a much smaller share of benefits. But in a matter of decades, that trend would reverse.
In 1979, the middle 60 percent of earners paid about 45 percent of overall taxes collected by the IRS and got 27 percent of means-tested benefits, such as food stamps or Medicaid, according to an analysis of working-age Americans released today by the Aspen Institute’s Economic Strategy Group.
By 2016, the most recent year for which data is available, the middle 60 percent paid just 31 percent of taxes and got a lot more of the benefits — including 49 percent of those distributed on a means-tested basis, meaning recipients needed to demonstrate financial need to qualify for them.
In theory, such dramatic gains should have transformed how we talk about the American middle class. Instead, these middle-class tax benefits were almost invisible. Some arrived in the form of traditional tax cuts, mainly for families with children, but most of these apparent gains are the depressing side effects of two of the greatest threats to a middle-class existence: income inequality and health-care costs.
In almost every economic cycle since 1975, the incomes of the wealthiest American families have grown faster than those of the middle class, according to recent analysis by Rand economist Kathryn Edwards and Rand mathematician Carter Price. Unequal income growth has caused most earners — the bottom 90 percent — to earn a total of $2.5 trillion less over that time than they would have if income had been distributed as equitably as it was in 1975, researchers found. (For context, $2.5 trillion is more than the total value of all goods and services produced by the U.S. economy in a typical six-week period.)
Slower pretax income growth and expansions of means-tested programs have funneled more benefits to the middle class, said Adam Looney, an author of the Aspen ESG analysis and executive director of the Marriner S. Eccles Institute at the University of Utah.
“The expansions of transfer programs that have happened over the past couple decades have really been about expanding programs further and further up the income distribution,” said University of Maryland economist Melissa Kearney, director of Aspen ESG.
Between 1979 and 2016, the middle-class share of U.S. pretax income fell from 51 percent to 40 percent, according to Looney and his collaborators, Federal Reserve economist Jeff Larrimore and Joint Committee on Taxation economist David Splinter. Their earnings grew, but not nearly as rapidly as those of the highest earners.
In the data, falling middle-class incomes can look a lot like rising tax benefits. After all, whenever anyone makes less income, they pay less in income taxes. Also, less income can mean individuals are more likely to qualify for federal programs designed to alleviate poverty.
Meanwhile, the top 20 percent of earners now shoulder 69 percent of the tax burden, up from 53 percent in 1979. But their share of income also rose to 59 percent, up from 47 percent.
“Part of the reason we’ve enacted lower tax rates on the middle class — and part of the reason we’ve expanded health insurance like Medicaid and CHIP (Children’s Health Insurance Program) to the middle class — is out of concern that the middle class is not sharing enough in the benefits of economic growth,” Looney said.
Rising health-care costs
America’s well-chronicled, rising health-care costs have caused a quiet sea change in the tax burden of the middle class.
Kosali Simon, at Indiana University’s O’Neill School, studies the economics of health care and co-wrote an earlier paper about little-noticed middle-class tax benefits, explaining the many ways in which rising health-care costs can change the middle-class tax burden.
As health-care providers develop new and often costly lifesaving treatments and costs climb, millions of middle-class folks pay more in premiums so their insurance can cover all those big new hospital bills. And almost all of those premiums paid through employer-based health insurance plans and similar programs are tax-exempt, Simon said, meaning every dollar devoted to the health-care system leads to less direct taxes paid by the middle class.
The Joint Committee on Taxation found that tax exclusions for employer-provided health insurance will have risen from $23 billion in 1979 to an expected $200 billion by 2022, after adjusting for inflation.
At the same time, spending also rose for Medicaid and CHIP as the programs adjust to cover costlier treatments, Simon said. That shows up in the data as benefits distributed to those middle-class workers enrolled in such programs. And the effect is compounded because rising health-care costs also spur politicians to expand programs such as CHIP and Medicaid to help families who are struggling to pay their medical bills. As the Medicaid rolls expand, the benefits reach more and more of the middle class.
So, on paper, the health-care cost crisis creates what looks like a reduced tax burden, but few people notice because it’s not reflected in their paychecks, Looney said. Instead, employer-provided health-care benefits tend to absorb a larger and larger share of cash income, and — because not everyone gets sick at once — they are distributed unevenly throughout the population.
Also, it’s not clear to most Americans the degree to which they benefit from all the increases in health-care costs, Simon said.
“Advances in medical technology and lifesaving care are all good things,” Simon said. “We value greatly the fact that we expect to get better and live these days even if we fall sick or get hurt in serious ways, because of all that. Of course, the problem is, we don’t know how to identify which of those treatments really helped us and what parts of those bills were things that could have been cut down without much harm.”
The role of federal policy
When we try to understand the shrinking middle-class tax burden, programs like the earned-income tax credit and the child tax credit, passed in 1998, are major pieces in the puzzle. These tax credits target low- and middle-income families and thus reach much of the middle class.
While specific numbers are tricky, Looney said, these family- and child-related benefits, along with the Bush tax cuts of 2001 and 2003, go a long way in explaining why middle-class before-tax and after-tax incomes began to diverge after the year 2000.
All together, changes in government fiscal policy explain about a third of the growth in after-tax, after-benefit incomes among the middle class.
“Federal policy has helped offset lower-than-average income growth,” Looney said. “That’s a very recent phenomenon.”
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