(This column is part one in a two-part series. Part two, “The number of those who pay no U.S. tax is actually miniscule,” discusses the common misunderstandings the public has about taxation.)
It is hard to find an economic statistic that is more misinterpreted or that gives rise to more silly editorial commentary than the fact that “half of all Americans don’t pay any taxes.” This is an example of a situation where some fact is true but so misunderstood that many people draw erroneous conclusions from it.
It is true that in any given year, nearly half of all “tax units” in the United States have no net federal income tax obligation. The proportion affected varies greatly with the economic situation, recently ranging from 39 percent in 2007 to 51 percent in 2009. The estimate for 2011 is 46 percent.
Many commentators do note that this involves only the federal personal income tax and that many of the units that pay nothing in this category do pay substantial amounts in FICA taxes, fuel taxes and minor amounts in excise taxes – not to mention state and local taxes.
What many people miss, however, is that the group of people who don’t owe federal income taxes is not static. It changes over time, principally with age or phase of life. Nearly everyone, including those who fret most loudly about the threat this situation poses to our democracy, spends some years in these non-paying categories. And nearly everyone, except for those severely disabled from childhood, pays federal income tax over some part of their lives.
Much confusion also stems from a misunderstanding of the term “tax unit,” used by the IRS in these tabulations and how this differs from “households” used by government agencies.
In 2009, there were about 307 million individuals in our country, according to U.S. census estimates. This translated to some 175 million potential “tax units,” defined as all individuals 18 or older minus the number of married women. (In other words, this assumes that all single individuals 18 or older could file their own return, but that all married couples will file jointly.) Eliminating those claimed as dependents by others leaves 159 million “tax units.”
This smaller number is the basic unit for analysis by the IRS and is used in computing the much-cited proportions of those who owe no tax.
In 2009, out of 159 million potential units, only 140.5 million returns actually were filed. About 1.8 million of these returns were by people younger than 18. Another 22 million were for those ages 18 to 26. Many at these ages are students, have part-time jobs or are in low-paying entry-level jobs, and hence, most don’t earn enough to owe any tax.
Similarly, 20.3 million returns come from those older than age 65, another group in which many have modest cash incomes, even including Social Security, although they do have many more assets, especially houses, than those younger than 26.
These two age groups account for just 32 percent of all returns filed, but a much higher fraction of all tax units paying no tax because many “units” in these age brackets have such low incomes they don’t need to file.
In 2011, it is estimated that for every 100 total tax units, 54 will pay some income tax. But 23 won’t, simply because their income falls below the threshold at which any tax is due. This is because of the “zero bracket amount” and personal exemptions that apply to all.
That leaves another 23 who won’t owe any tax or will even get a net amount back because of special exemptions, deductions or credits collectively called “tax expenditures.” These are the bone in the throat of those exercised over the fact that “half of the people don’t pay tax.”
Of those 23, 11 pay no taxes because of the extra exemption for people older than 65 and because most Social Security benefits are not taxed.
A few more don’t owe tax because of exemptions for interest earned and/or minor tax-free dividend and capital gains income or because of itemized deductions, including those for charitable donations and home mortgage interest.
The upshot is that only nine of the 46 who don’t owe taxes escape because of factors like the Earned Income Tax Credit and other credits for low-income people, education credits and a few other special provisions.
The total cost of all tax expenditures runs into the hundreds of billions. But most of the benefits flow to those who do pay some net tax. Eliminating all tax expenditures entirely would bump many tax units back into the paying category. But the extra taxes paid by this group would add very little to revenues. Whether tax justice or incentives for healthy democracy would benefit is the subject of another column.
© 2011 Edward Lotterman
Chanarambie Consulting, Inc.