Why do so many Americans pay no income taxes?

Why do so many Americans pay no income taxes?

Today many are discussing how many Americans do not owe income taxes. The traditional debate splits along partisan lines. Many Republicans and conservatives argue it is both unfair and politically dangerous to have (almost half / more than one-third, depending on who’s measuring) of Americans not owing any income taxes. Many Democrats argue the rich should pay more, and that it’s good that low and even moderate-income people owe no income taxes.

I wonder how many Republican Members of Congress remember that they are, in large part, responsible for this outcome?

First, here’s a quick refresher on the difference between a tax deduction and a tax credit:

  • Suppose you make $60,000 per year. If you donate $5,000 to charity, you get a $5,000 deduction. You pay income taxes on only $55,000.
  • Suppose a married couple finds they owe $12,000 in income taxes before accounting for the child credit. If they have three kids, they get a $1,000 tax credit for each child, for a total of $3,000 in tax credits. They subtract this $3,000 from their $12,000 of income taxes owed, leaving them owing $9,000 after accounting for the child tax credit.
  • Suppose this same family owed only $2,500 in income taxes before accounting for their three children and the child tax credit. Since the child tax credit is refundable, the $3,000 credit wipes out all of their $2,500 of income tax liability and they get $500 from Uncle Sam.

The reason so many Americans don’t owe income taxes is because we have two big tax credits in the code: the Earned Income Tax Credit (EITC) and the child tax credit. I hope the above explanation shows the power of a tax credit: one dollar of tax credit wipes out one dollar of tax liability. So if you provide a big tax credit to someone who owes only a small amount of income taxes, you’re probably going to move them into the non-payer category.

The EITC benefits low-wage earners. Legislative support often splits roughly along party lines, with most Democrats wanting a bigger EITC, and many Republicans wanting a smaller (or, at least, no bigger) EITC. Republicans like to complain about the EITC on a day like today.

But most of the increase since the mid-1990s in the number of people who owe no income taxes is the result of the child tax credit. This policy was created by Congressional Republicans and expanded with Republicans in the lead.

The nonpartisan Tax Foundation has measured the top nonpayer threshold. This is the highest income taxpayer that owes no income taxes, setting aside unusual tax situations. They looked at how the top nonpayer threshold changed from 1993 to today for a married couple with two kids. All figures are in 2010 dollars for comparison:

  • In 1997 every “normal” married couple with two children that earned $24,000 or more (in today’s dollars) had to pay at least some income taxes. The top nonpayer threshold for a family of this size was just under $24,000. This means there were some four-person families with income just below $24,000 that owed no income taxes.
  • In 1997 a Republican majority Congress and President Clinton enacted the Balanced Budget Act. At the insistence of Congressional Republicans, this law created a $400-per-child tax credit which began in 1998. This caused the top nonpayer threshold to jump more than $7,000, to about $31,300. Millions of families with kids with incomes between $24,000 and $31,300 were “taken off the rolls” because the child tax credit wiped out the small income tax liability they owed.
  • As a result of the 1997 law, in 1999 the child tax credit automatically increased to $500 per child, and the threshold for a married family with two kids grew to $32,800 in today’s dollars.
  • In 2001 President Bush and the Republican Congress enacted a major tax law that increased the child tax credit to $600. This law also introduced the 10% income tax bracket, which lowered by 5 percentage points the lowest income tax rate. The combination of these two tax changes raised the top nonpayer threshold to $38,700. That law further phased in over time increases in the child credit to $1,000 per child.
  • The 2003 tax law enacted by President Bush and the Republican Congress accelerated the $1,000 per child amount to be effective immediately. This increased the threshold to $47,400 in 2003. That’s a huge jump. It was incredibly popular, and it helped create political impetus for the 2003 law which also accelerated rate reductions and cut capital gains and dividend rates.
  • The 2008 stimulus (President Bush + Democratic majority Congress) included stimulus checks of $1,200 per married couple, plus another $300 per child. This increased the threshold to $56,700. This was a one-time increase, however, and the non-stimulus threshold for 2008 was about $44,500.
  • In 2009 President Obama and a Democratic majority Congress increased this threshold to $51,400 with the new “making-work-pay” tax credit. This was enacted on near party-line votes. That threshold drops slightly to about $50,300 this year.

What can we conclude from this?

  • The huge number of Americans who owe no income taxes is the result of the interaction of three tax policies:
    1. a progressive rate structure and a standard deduction;
    2. the Earned Income Tax Credit, which significantly reduces tax liability for the lowest earners;
    3. the per-child tax credit, which significantly reduces tax liability for low- and moderate-income families with kids.
  • Different political coalitions support these three policies:
    • There is broad-based political support spanning both parties for a progressive rate structure. Republicans split on this point, with some conservatives favoring a flat tax. Even many flat tax supporters support some progressivity with a large(r) standard deduction.
    • Support for expanding/keeping EITC tends to be center-left. Many on the right oppose it at its current size.
    • Support for the per-child tax credit is nearly universal, but it started on the right.
  • The large number of people who owed no income taxes until the mid-90s was driven largely by the first two factors and especially by the Earned Income Tax Credit, a policy driven by the Left.
  • The dramatic increase in the number of people who owed no income taxes since the mid-90s was driven almost entirely by the creation and expansion of the per-child tax credit, a policy driven by the Right.
  • This was a “pro-family” tax credit created in the 1994 Contract with America, pushed to a veto by Congressional Republicans in 1995, negotiated with President Clinton in 1997, and expanded by President Bush and Republicans.

Behind closed doors Republicans split on the per-child tax credit. Economic types oppose it or hold their noses. Social/family conservatives vigorously support it, as does almost anyone running for office.

It’s easy for Republicans to complain today about the end result. They (we) have an out in that they can point to the EITC as one of the causes. But much of this outcome is driven by tax policy changes initiated and expanded by Republicans.

If you wanted to work within the current income tax system and reverse some of this trend, broadening the income-taxpaying base, you’d be hard pressed to get a big effect just by raising the bottom rates. To affect millions of people you’d need to either scale back EITC or the per-child tax credit. I think both are highly unlikely.

(photo credit: hope and megan)

50 responses

  1. Pingback: While You Were Working – Tax Day Edition

  2. …another prime example of good legislative intentions gone bad. Which is why it seems foolish in the extreme to continue to believe that more government is the answer.

  3. Also, should social security and medicare payments be considered along with income taxes? That would have a significant effect on this threshold, and also make the tax code appear a lot less progressive. I'm not sure how to make the decision about whether those taxes should be included.

  4. I seem to recall in my Economics training that Milton Friedman proposed refundable credits for low income people. But if the levels are too high now maybe congress should not adjust the thresholds just like they treated the AMT. On another topic – good job last week on the questioning and what is the "iron triangle" concept?

    • Under Nixon, Friedman did propose a "negative income tax" as he described in Capitalism & Freedom, but as a replacement of all other government welfare programs. Because that wasn't politically feasible, he ended up lobbying against his own proposal.
      He talks about it in his documentary Free To Choose, episode 4: From Cradle To Grave.

  5. wait, wait — so if I paid the correct amount all year, and owe nothing on April 15th, I am still lumped in with this group? That inflates the numbers — I don't get a refund/ don't owe = GOOD, or so I used to think…

  6. If you include social security and medicare, everyone pays some taxes. Everyone will be paying a lot more once ObamaCare kicks in, since it applies the Medicare tax to investment income. And once the Democrats impose a VAT (they really have no choice in the matter if spending remains at projected levels), everyone will be paying through the nose, just like in Europe.

    • Specious at best. Everyone earns investment income? Maybe in your universe. Those who will be giving back will be doing so at Regan levels as it was the Shrub that gave the wealthy who live off their investments the additional break; in short not you, and boo hoo, the party's over. If you don't have the investment sense to put your money in vehicles exempt from the tax you speak of, don't blame Obama. As far as the VAT chimera, does that come dressed as 10,000 IRS agents flying around in black helicopters.

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  8. Truth to be said, in a society that will soon feel all the weight of the baby boomers retiring, the per-child tax credit should be seen as an investment, more than anything: more kids=more people paying taxes and previous generations' entitlements in the future.

    It's either more kids, more immigration or (a lot) less entitlements or a combination of the three, to keep going. perosnally, I'd go for the first option.

      • True, but in that case it doesn't matter anyway, does it? As there wouldn't be anything to sustain the entitlements with future worker or not :)

    • How about less children more tax if you breed? Investment? When octo mom is not paying any taxes and dropping kid bombs all over the place. Who pays for these kids to be raised, educated, given all resources? We do! I want young people to get a strong education, affordable health care…(so they don't go bankrupt when they break a toe. Learn that having one or two children in the country is plenty!!! I want to know why it's ok for a family to breed like crazy..get benifits for it and they turn their nose to women that get welfare, well the ones that don't abuse it. If you have more kids than you can afford it's abusing the country the people and the child. More kids! Pffft! Yeah how many have you adopted. Disgusting! Hey more kids-more bridges, more cars, more buildings, more schools. Uh who is going to pay for this? I thought we were in a recession!

  9. Every time a citizen/consumer opens their pocket book to purchase anything at the retail level,that purchase pays the entire tax burden that good or service. It's not a question of whether the money is collected,but rather is it better to allow the money to produce economic growth first instead of a pre-emptive removal from the free market. Either supply side economics works or it doesn't. Let's remove ALL individual incomefrom taxation and find out.

  10. Don't forget the $8,000 homebuyers tax credit.

    Don't forget people like Fox Newscorp owner Rupert Murdoch pay litte if any income tax in
    the United States. U.S. corporations like General Electric & Halliburtion pay no taxes and get refunds.

  11. I don't disagree that Reps share an equal part of the blame for the fact that 47% of americans pay no federal income tax. That isn't the point. The point is, what are we going to do about it. Everyone (EVERYONE) should pay at least a little bit; there's a moral element in everyone participating and contributing to the general welfare. But it wil never happen. Both the Reps and Dems have sacred cows they'll exempt forever.

    • Your right, I feel like if your going to breed, then you better be able to be taxed for them and all the other taxes that go into supporting that child- soon to be a consumer. Why is it that unless raped of course do americans feel like the country owes them something. Republicans want smaller gov, no welfare, lower taxes but never NEVER do they complain about americans breeding to much and not able to afford it, well they do with welfare but not a family. Ok so if your pro family it's ok to smooch on the system and then have more kids than you can afford? I don't get it. Tax the hell out of anyone that wants more kids. The more you have the more you pay!

  12. It's the inevitable path of politics. Dish out benefits with great fanfare and hide the costs. Unfortunately the only real corrector is a crisis.

  13. A "refundable" tax credit is just a nicer-sounding word for "welfare". In my opinion, there should be a minimum tax that all Americans should pay, even for those below the poverty line. Even if the minimum tax for the poor is as small as the cost of a cup of Starbucks coffee, it drives home the point that government is an EXPENSE. It may be a necessary expense, but it is never free.

    Repeal refundable tax credits. We need an alternative minimum tax on both the low and high ends of the spectrum.

  14. The real rub is that most of the people who don't pay federal income taxes actually think they do. Many of them believe they are also overtaxed.

    With headwinds like that, I'm not sure progress is possible.

    • Can you cite a poll supporting this conclusion? It may be that a few percent of wage-earners don't comprehend their own tax returns, but I can't believe anything close to 47 percent of tax filers is that oblivious. I'm in that 47 percent who pay nothing, and I know it well.

  15. the real answer: so many Americans pay no income taxes because so many are living in poverty or near it. Treat the disease, not the symptom!

  16. Pingback: 47% of Americans don’t pay income taxes : Off the Axis

  17. Did I overlook mention of the mortgage deduction? One of the reasons not often mentioned for the real estate meltdown.
    Isn't the idea of not paying taxes, legally, something of a conservative holy grail?
    In a consumer society you can have it one of two ways. Tax the majority of people and fund a welfare state or by not taxing them give people incentive to buy things that creates a flow of goods and money . The latter idea is the one most put forth by Republicans..except they apparently are talking about the rich and not everyone else.

  18. It drives me crazy that people only think of "income tax" when they use the shorthand phrase "taxes." Everybody pays taxes — sales taxes, property taxes, FICA, etc. — and most of those taxes are regressive. The income tax is perhaps the most progressive tax paid by lots of people, and it helps balance the others — sometimes inadequately, since some analyses show poorer classes paying as much or more of their income in taxes than higher income groups.

    When we don't look at the total tax burden, we get all kinds of angry, cynical, or just incomplete responses.

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