Effective Personal Income Tax Rates Lower than You Think

Brian Murply and Paul Roberts from StatsCan presented an interesting and potentially very useful and important study to this week’s StatsCan Socio-Economic performance.

The effective personal income tax rate is typically computed – across various data sources – as total taxes paid as a ratio of total or taxable personal income. This ratio of two overall averages is accurate enough as a measure of the size of the tax “burden” relative to personal income. But it is more than a little misleading as a measure of the effective tax rate paid by the “average” taxpayer, which is much lower.
Rather than the easily calculated “top down” ratio of total income taxes to total income, Murphy and Roberts develop a “bottom up” methodology  and calculate an average effective tax rate based on the average tax rate for each person or family in the distribution (an average of ratios.)
The key insight here is that rather few taxpayers pay anything like the “top down” average effective rate, and that the average of effective rates is much lower than the usually reported number.

To take one example – 10 taxpayers with a total income of $100 pay a total of $30 in tax, so the average effective tax rate for the group by the first measure is 30%.

However, if taxpayer 1 has an income of $30 and pays $15 in tax (50% effective tax rate); taxpayers 2, 3 and 4 have incomes of $20 each and  pay $5 in tax (3 times 25%) and taxpayers 5-10 have incomes amounting to $10 in total and pay no tax – the average effetive tax rate  is just 12.5% (the average of 1 person at 50%; 3 persons at 25%, and 6 persons at zero.)

Since the distribution of income is tilted to the high end, with a lot of people paying little or no tax, the actual universe is not all that distant from this example.

The bottom-line finding is that average effective personal income tax rate across a number of different surveys – including CRA and SLID data – is only about 9%, or a little more than half the top down rate of about 17%.

The calculation has some interesting implications.

Most people are paying much less than they are told (or, for that matter, than they think.) Certainly the Fraser Institute will have to move “tax freedom” day to considerably earlier in the year.  And progressives have a bit more ammunition to argue that lots of folks are better off when we tax personal incomes to pay for social programs and public services.

4 comments

  • Iglika Ivanova

    The StatsCan analytical report on the most recent Census income data, Earnings and Incomes of Canadians Over the Past Quarter Century, 2006 Census, also talks about the effective income tax burden for economic families. Buried towards the end of the report, in the section discussing after-tax incomes in Canada, is the following finding:

    “The proportion of the [economic family] income that is paid in taxes ranged from 2.8% in the bottom quintile, to 13.6% in the middle quintile and to 24.2% in the top quintile.”

    I’d say that this is even more interesting than looking at the average rates, given that the income distribution is so skewed as you point out.

    As for “tax freedom” day, to be fair the Fraser Institute includes a lot more than income tax in its estimation which partly explains the large tax burdens they end up with. That being said, the Center on Budget and Policy Priorities in the US recently posted a piece analyzing the major problems with the Tax Foundation “tax freedom” day and why it doesn’t represent the tax burden for the average American family, which can be found here. A lot of the arguments can be applied directly to the Fraser Institute calculation.

  • For another purpose (a study to be released today in fact by the CCPA on corporate tax cuts), I just looked at the average effective federal PIT rate and how it has changed. It is about 10% (even using the biased averaging approach), and has hardly fallen at all this decade. Compare that to the 2/7 cut in the GST rate, and the cut in federal CIT rates that will reach almost half by the time the current cuts are phased in. So there’s two conclusions here: personal income taxes are much lower than you think, and the value of PIT cuts is also much lower than you think!

  • Jim, I am inclined to put things a bit differently.

    Given a progressive rate structure and increasing income inequality, one would have expected a significant rise in the ratio of total income-tax revenue to total personal income. The fact that this ratio instead declined reflects deep (and costly) income-tax cuts.

    The value of these tax cuts has been modest for the median taxpayer, but quite large for those with high incomes.

  • It would seem with all the tax cutting and shifting and the increasingly further distributional skewing of income, and costs of living movements from the dollar, it is a topic that needs revisiting for sure.

    How much we each are getting, who is paying the taxes, and how much things cost – I think we would all have some big surprises.

    I think individually we have answered some of these questions, and need to update like that above who is paying the taxes question.

    However, I have yet to see an entire model of all three of these questions combined. Not even statcan has that, at least from what I am aware. But given the data sources that are available, it could be done. Not easily though.

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