Tax Foundation's Tax Freedom Day Does Not Represent Typical Households' Tax Burdens

The Tax Foundation has released its annual "Tax Freedom Day" report. The Center on Budget and Policy Priorities explains the flaws in this report.

The Tax Foundation released its annual “Tax Freedom Day” report today that, once again, can leave a strikingly misleading impression of tax burdens — showing an average federal tax rate across the United States that’s likely higher than the tax rate that 80 percent of U.S. households actually pay.

To project the day when “the nation as a whole has earned enough money to pay its total tax bill for [the] year,”[1] the Tax Foundation calculates the average tax rate by measuring tax revenues as a share of the economy (similar to estimates of total revenues as a share of Gross Domestic Product, or GDP).

In a progressive tax system like that of the United States, only upper-income households on average pay federal tax at rates that are equal to or above federal revenues as a share of the economy. Estimates from the nonpartisan Urban-Brookings Tax Policy Center show that low- and middle-income households (about 80 percent of all households) will pay a smaller share of their income in federal taxes this year than the Tax Foundation’s average tax rate.

The Tax Foundation acknowledges this issue in a methodology paper accompanying its report, noting that its estimates reflect the “average tax burden for the economy as a whole, rather than for specific subgroups of taxpayers.”[2] Consequently, those who report on Tax Freedom Day as if it represents the day until which the typical American must work to pay his or her taxes are misinterpreting these figures and inadvertently fostering misimpressions about the taxes that most Americans pay.

Moreover, the Tax Foundation suggests that people spend part of the year working for the government and part of it working for themselves, becoming “free” only when they get to work for themselves. In reality, taxes pay for services that benefit us every day and are central to our idea of freedom. Few Americans would likely feel more “free” if Tax Freedom Day came earlier in the year because the federal government stopped providing for national security, ensuring homeland security, conducting food safety inspections, or testing prescription drugs.

Finally, the report’s estimates of state and local tax burdens suffer from a number of serious methodological flaws (see box below).

Tax Foundation’s State-by-State Estimates Are Seriously Flawed

The Tax Foundation’s proclamations of state Tax Freedom Days are meaningless because the report’s state-by-state estimates are flawed.  They are not useful for discussing the level of taxes paid by typical households or for assessing the tax choices made by a given state’s policymakers, for at least four reasons.

  • They overstate middle-class tax levels.  About two-thirds of the taxes in the Tax Foundation calculations are federal taxes.  The amount of federal tax paid by the residents of a state thus has a large impact on that state’s Tax Freedom Day.  Since, as this analysis explains, the Tax Foundation methodology substantially overstates the federal tax burden of middle-class families, the Tax Freedom Day figures for each state also substantially exaggerate the tax burdens of middle-class families in that state.
  • They reflect state affluence rather than state taxes.  Because the federal income tax system is progressive, states with greater numbers of high-income residents pay more federal taxes than states with fewer high-income residents.  As the Tax Foundation acknowledges, “This means higher-income states celebrate Tax Freedom Day later.”  Yet by trumpeting state-level Tax Freedom Days that differ across the states, the Tax Foundation presentation is likely to lead to the misimpression that state and local policies account for the differences, when that is not the case.
  • They include taxes paid in other states.  The Tax Foundation uses a procedure to allocate state corporate, severance, and tourism taxes based on the residence of the consumers who purchase products that businesses sell (adjusted for taxes that tourists pay).  This is likely to lead to further misimpressions about the impact of a state’s tax policies on the tax burdens its residents face.  For example, when Alaska collects taxes from oil companies based on companies’ revenue and profits from Alaskan oil, the Tax Foundation does not count those taxes as part of Alaska’s revenue.  Rather, it adds those taxes to the tax calculation in the states where oil is consumed.  Maine residents, for example, consume a significant amount of fuel and so get allocated a large share of these Alaska taxes.  Yet state legislators in Maine cannot have much impact on the level of taxes that Alaska or other oil-producing states levy on oil.
  • They rely heavily on estimates, projections, and imputations from years-old data.  While the Tax Foundation uses Congressional Budget Office (CBO) data to project total federal tax collections, there is no equivalent of the CBO for state and local governments.  Rather, the Tax Foundation uses its own proprietary (non-public) model to estimate taxes that will be collected during the year in tens of thousands of state and local jurisdictions around the country. This model is based in part on data that are several years old.  If the estimates turn out to be even slightly wrong, the rankings are likely to be completely askew, since — as the Tax Foundation itself indicated in a separate report last week — “state-local tax burdens are very close to one another and slight changes in taxes or income can translate to seemingly dramatic shifts in rank.”
  • This has happened at least once.  The Tax Foundation’s 2002 report claimed that tax burdens had risen in 38 states since 2000, but subsequent Census Bureau data for 2002 showed that tax burdens had risen in only four states and fallen in most of the rest.

For all these reasons, the Tax Foundation’s proclamations of state Tax Freedom Days are misleading and do little to inform legitimate debates over state and local taxes and the services they support.

*See Nicholas Johnson, Iris Lav, and Joseph Llobrera, “Tax Foundation Estimates of State and Local Tax Burdens Are Not Reliable,” Center on Budget and Policy Priorities, March 27, 2007.

Read the Full Center on Budget and Policy Priorities Analysis

Footnotes

[1] Kyle Pomerleau, Lyman Stone, “Tax Freedom Day® is April 21, Three Days Later Than Last Year,” Tax Foundation, April 7, 2014, http://taxfoundation.org/article/tax-freedom-day-2014-april-21-three-days-later-last-year.

[2] See Tax Foundation Staff, “Tax Freedom Day: A Description of Its Calculation and Answers to Some Methodological Questions,” Tax Foundation Working Paper No. 3, March 2008.