Obamanomics and Tax Relief for the “Middle Class”
November 13, 2008
William F. Shughart II
Although President-elect Barack Obama’s economic policy agenda is likely to be derailed by the ongoing financial crisis, he campaigned on a platform promising permanent tax relief of at least $1,000 per year for middle-class American families. The first down payment on that long-term fiscal plan was to be in the form of an immediate “emergency energy rebate”, financed by enacting a windfall profits tax on “excessive” oil company profits. With crude oil prices now heading south, the money will obviously have to be found elsewhere.
But who embodies the middle class? A household that earns less than $250,000, as defined by Mr. Obama—or is the upper limit on tax relief closer to Vice President-elect Joe Biden’s $100,000 figure?
Although the “middle class” is a very fuzzy concept, a general idea of what it means to be of “middle income” is possible. The U.S. Census Bureau divides household incomes into quintiles, each containing one-fifth of the total. On that basis, the 20 percent of households at the center of the distribution constitute the middle.
In 2007, the middle 20 percent of American households had annual incomes of between $39,100 and $62,000. The distribution of household incomes is far from a bell curve, however. Nevertheless, identifying the middle 20 percent of households as “middle income” is sensible because that quintile also contains the median-income household, which at $50,233 per year, slices the distribution exactly in half.
The lifestyle a household income supports also determines whether or not one is in the middle class. What the Smiths are able to buy and consume, in comparison with the Joneses, is often more important than income, education, or the color of a breadwinner’s collar. Expectations matter—and they change considerably over time. Americans may once have been satisfied with Herbert Hoover’s definition of progress as “a car in every garage and a chicken in every pot,” but nowadays, members of the middle class aspire to have two cars in the garage, to own their own homes, to have flat-screen TVs and personal computers, to send their kids to college, and to retire on something more than a modest social security check.
Households are diverse, of course, and whether an income in the middle 20 percent means belonging to the middle class depends on many factors, including the number of income earners living under one roof. (Based on 2005 data, the median dual-earner household made $67,348, or $21,000 more than the overall household median.) Total household size and location also count. A household making $50,233 or even $67,348 per year is clearly much better off in, say, Hattiesburg, Mississippi, than in New York City.
Another factor is how much income a household actually gets to keep. Although 32 percent of the households filing federal income tax returns in 2005 owed no tax, the average household in the middle 20 percent of the income distribution faced an effective federal income tax rate of 14.2 percent that year. Washington’s take thus reduced the median household’s after-tax disposable income by $6,578.
The fact of the matter is that 80 percent of U.S. households earned less than $100,000 in 2007. To be in the top five percent last year, a household had to make at least $177,000. So, under one of the new administration’s definitions of the middle class, the federal tax burden would rise again for the top 20 percent of households; under the other, taxes would be increased on roughly the richest 2 or 3 percent.
Evidence from the tax cuts of the early 1960s to those in 2003 consistently shows that lowering tax rates on incomes, capital gains, or other earnings produces more tax revenue. And because nearly half of total 2007 household income was earned by households in the highest quintile, they pay the lion’s share of the federal tax bill. Tax relief must necessarily favor the “rich” to effectively generate additional revenue. Clearly, that goal would be defeated if tax relief is limited to the “middle class,” as outlined on the campaign trail.
William F. Shughart II is a Senior Fellow at The Independent Institute, Frederick A. P. Barnard Distinguished Professor of Economics at the University of Mississippi, and editor of the Independent Institute book, Taxing Choice: The Predatory Politics of Fiscal Discrimination.