Taxes are often spoken about in simple terms by politicians. “I promise to lower taxes”, is the common cry of a presidential candidate. The reality is that the US tax system is complicated. Taxes can’t be boiled down to a single sentence. Even a simple question such as: “what is the average tax rate in the USA?”, requires quite a bit of leg work to answer. Let’s try and answer that question to see how complex it truly is.
Americans pay taxes in four distinct areas, federal tax, state/local tax, Social Security tax, and Medicare tax. Let’s tackle them one at a time.
Let’s start with a high-level explanation of federal tax brackets. Federal tax brackets follow the simple logic that those who earn more pay a higher percentage of their income in taxes. For example, salaries under $9,525 in a year pay 10% in federal taxes. Salaries over $500,000 pay 37% in federal taxes. There are 5 tax brackets separating the lowest earners from the highest earners. The 5 tax bracket rates in increasing order are 10%, 12%, 22%, 24%, 32%, 35%, 37%. If we take the median of these tax brackets we might think the average tax rate is close to 24%. We would be wrong. The United States operates in a progressive tax system. Let’s see what that means in a real-life example.
Those earning between 84,200 and 160,725 dollars a year fall in the 24% tax bracket. Does this mean they pay 24% of their salary in taxes? No. The 24% tax rate only applies to their income between 84,200 and 160,725. If someone earned $84,201 in a year, they’d only pay the 24% rate on $1. You can see how this makes finding the average tax rate a difficult endeavor.
A more holistic way to tackle the problem is to take the total federal tax revenue divided by the number of tax returns received by the IRS. In 2015, the IRS received $1.454 trillion in tax revenue, based on 150.6 million tax returns. Some quick division shows us that the average taxpayer paid $9,650 in income tax. Since the average income in 2015 was ~$71K per year, this makes the average federal tax rate ~13.5%.
State taxes are harder to figure out. Different states and localities levy different tax rates on their citizens. Some states such as Texas don’t charge an income tax at all. Other’s charge over 10%. According to the US Census Bureau, American’s pay an estimated 9.9% of their income in state and local income taxes each year.
Social security tax is taxed at a 6.2% rate on employees and employers. However, the tax only applies to the first $127,200 of earned income. For Americans making less than $127K, they are taxed at the 6.2% rate, for those earning more, the rate will be lower. Social security tax gets even more complex. For individuals who are self-employed, they are taxed as both the employer and the employee. This means they have to pay both sides of the tax. In 2015, Social Security took $680 billion and Americans created $7.3 trillion dollars in income. Quick division gets us a Social Security tax rate of 9.3%. Halve that and we get 4.7%.
The last section of taxes that Americans pay into is Medicare taxes. The Medicare Tax is taxed at a 1.45% rate for both employees and employers on all earned income. Higher earners pay more into the Medicare tax. Similarly to social security, self-employed individuals pay both the employer and employee side of the tax. If we use the same methodology as was used to calculate the average Social Security tax, we find that the Medicare tax rate is 3.3% overall or 1.65% per individual. We get 1.65% rather than 1.45% because we’re accounting for high earners and self-employed individuals who might pay more than the 1.45% rate.
So what’s our total tax rate? If we take the average federal tax rate of 13.5%, the average state tax rate of 9.9%, the average Social Security tax rate of 4.7%, and the average Medicare tax rate of 1.65%, we get a total average of 29.75%.