Who Should Pay Federal Income Tax?

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By Josh Barro

The Tax Foundation (my former employer) has a new report out about the increasing number of tax filers who don’t pay federal income tax. I don’t like the foundation's effort to slap the “nonpayers” label on these people; it suggests freeloading, even though most people who don’t pay federal income tax do pay payroll tax and a variety of state and local taxes. Still, the rising share of the population that is excluded from the federal income tax is an important policy trend.

Forty-one percent of federal income tax filers paid no income tax in 2010, down from a record of 42 percent in 2009. While the income tax started out about 100 years ago as a narrow tax on very high earners, between 1950 and 2000 a large majority of the population paid income taxes, with the share of non-paying tax filers generally varying between 15 percent to 25 percent. Only since 2000 has that figure risen to the 30s and then the 40s.

What changed in the last 15 years? Mostly, it’s a proliferation of tax credits -- the child tax credit (created during the Clinton administration and expanded under George W. Bush), tax credits for education, and, in 2009 and 2010, the Making Work Pay credit, which was simply a $400 per taxpayer credit for most filers. These tax credits wipe out the total amount of income tax due for an increasing number of tax filers.

At the end of the report, you can see the effects by income range over the period from 2001 to 2009. The biggest moves are in the middle. In 2001, only 7.2 percent of taxpayers making between $30,000 and $40,000 a year paid no federal income tax. By 2009, that figure had risen to 33.4 percent.  For the $75,000 to $100,000 range, the share went from 0.3 percent to 4.1 percent.

2009 was likely the peak year for filers paying no income tax, since the Making Work Pay credit expired in 2011 and the economic recovery is raising incomes. Still, levels in the 30s that we saw during the 2000s are likely the new normal -- and lots of families that would have paid federal income tax under the Clinton-era tax code now won’t.

I don’t have a strong opinion on what percentage of taxpayers ought to pay federal income tax. There are other ways to tax the middle class -- we could even raise the payroll tax or impose a VAT while further increasing the share of taxpayers who don’t pay income tax. On the other hand, I don’t think the tax code of the 1990s was manifestly unjust, and it raised a lot more revenue than the one we had today, in part by offering fewer income tax credits and deductions.

The rise in tax filers not paying income tax hasn’t, by itself, been a huge hit to revenue -- most of these people would otherwise have had small tax bills. But it is a symptom of the fact that we spent the 2000s giving away tax breaks that weren’t affordable. Letting the entire Bush tax cuts expire once the economy has recovered would be good fiscal policy, and it would also happen to increase the share of tax filers who pay income tax.

(Josh Barro is lead writer for the Ticker. Follow him on Twitter.)

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-0- Jul/23/2012 21:12 GMT