In everyday speech, “average” and “typical” are pretty much interchangeable. But the difference between them is real when talking about taxes and tax policy, and is especially important as income inequality grows.
The difference is often illustrated by a story that goes something like this. Sven and Ole, each of whom earn $50,000, are having lunch at the local coffee shop. Bill Gates walks in, and Sven yells, “We’re rich!”
Based on their average income, they’re all millionaires now. But the median income – where half of the people have a higher income and half are lower – is still $50,000, and is the more “typical” income of the three men at the coffee shop.
So what does this have to do with taxes? When determining how much you pay in taxes and whether a particular tax affects you, whether you make $50,000 or are a millionaire makes a real difference.
A current example of this is Tax Freedom Day, which the Tax Foundation says is April 23 this year. The Tax Foundation notes that their figures are averages, but since their press release and report simply refer to “Americans”, their results have been frequently misinterpreted as representing a “typical” level of taxes paid.
But 80% of American households pay a smaller share of their incomes in federal taxes than the average found by the Tax Foundation. According to the Congressional Budget Office, “typical” Americans – the 20% of households in the middle of the income distribution – paid 14.2% of their income in total federal taxes in 2005. In contrast, the Tax Foundation’s average share of income paid in taxes for that year is 20.2%.
So let’s keep the two concepts straight in tax policy debates. Because Sven and Ole don’t need to worry about paying the estate tax or a new 4th-tier Minnesota income tax rate, no matter how many times Bill Gates joins them for lunch.