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Wednesday, June 3, 2015

The Income Taxes of the Bottom Half

The Income Taxes of the Bottom Half

Jon N. Hall

In 2014, an unmarried American with a total income of $10,155 under age 25 and eligible only for the "standard deduction" would have had a taxable income of $5, and thereby owed the federal government the grand total of $1. One dollar is the lowest (positive) tax liability for the federal individual income tax, and for the lowly income above, it amounts to an effectivetax rate of less than 0.01 percent.

One can only hope that Congress is wise enough not to spend that all in one place. Our hypothetical taxpayer, however, can hold his head high, because he is at least paying something for the blessing of living in America, unlike millions of Americans who have incomes but pay nothing in income taxes.

Shouldn't everyone with an income pay income taxes? Low-income earners aren't allowed to skip out on paying payroll taxes, sales taxes, Obamacare taxes, etc., so why doesn't Congress require them to pay income taxes? A tax rate of 1 percent doesn't seem like too much to ask. With a 1-percent tax rate, our hypothetical taxpayer would owe the feds $101.55 on Tax Day, less than $8.50 a month.

The first reason that some folks who have incomes don't pay income taxes is because no one pays taxes on his first dollars of income. Claiming just the standard deduction and exemption, an unmarried American would need to have a 2014 income of more than $10,150 to have any tax liability. Married couples, the elderly, and those with dependents can deduct more, and some income earners can reduce their taxable income further still by itemizing their deductions. So low-income earners who pay nothing in income taxes are merely using the system the way others do.

But there are some earners who contribute less than nothing in income taxes; they get money from the IRS just for filing a tax return. Such earners might use the earned income tax credit. The use of refundable tax credits, like the EITC, has become so widespread that for years the bottom 40 percent of income tax filers has "paid" a negative income tax. That doesn't mean that everyone in the bottom two quintiles pays nothing, as even those with the lowest incomes can have a federal income tax liability, like our example above. What it does mean is that the total of "refundable tax credits" is more than the total of tax bills paid by those in the bottom 40 percent.

According to the IRS, in 2013 the EITC distributed $66B in credits to 28 million tax filers. That $66B is more than what the bottom half of taxpayers has been paying. For years now, the bottom half of income tax filers has accounted for less than 3 percent of the total revenue from the federal individual income tax; 3 percent of the $1.4T total revenue in 2014 is $42B.

It would appear that not only the bottom two quintiles of taxpayers, but the bottom half of the middle quintile also "contributes" a negative tax. In other words, much of the bottom half of tax filers file their tax returns in order to get money, not pay it. In 2014, the average EITC benefit was $2,407.

But the EITC may affect not only the bottom half, as adjusted gross incomes as high as $52,247 could qualify for the EITC in 2014. That income happens to be more than what the median household incomehas been in recent years. Welfare programs are moving into the top half.

It took an income of $47,261 to get into the middle quintile in 2014. A nuclear family with three kids and an income of $47K filing jointly and taking the standard deduction and exemptions would have had a tax bill of $1,488, and an effective tax rate of 3.165 percent. But if they went through the rigmarole of the EITC worksheets, they could have knocked their tax bill down to $350, which makes for an effective tax rate of less than 1 percent, or to be more precise 0.744 percent.

Another taxpayer who also has a $47K income, but who is unmarried and eligible only for the standard deduction, would have a federal income tax bill of $5,078, and pay at an effective rate of 10.8 percent.

So here we have two taxpayers in the bottom 40 percent who have identical incomes, and one is paying more than 14.5 times the taxes than the other. For progressives obsessed with "equality," please justify that. For those who have "equality" on the brain, tell me how "equitable" it is for a person who is in the next-to-bottom quintile to be paying more taxes than 14.5 families who each have the same income as he does.

Democrats are continually harping on and on about "income equality," but one taxpayer here is getting virtually a free ride. In fact, if the family were to itemize their deductions or take additional refundable tax credits, they might easily owe nothing and get a refund, even though they're on the cusp of getting into the middle quintile. Politicians like to invoke the "marriage penalty," but the real penalty is reserved for the young, the unmarried, and the childless. (Check out "The I.R.S. Continues to Hose the Young" at Stubborn Things.)

And another thing: that 10.8 percent effective tax rate paid by our unmarried taxpayer is a higher effective rate than theaverage effective rates of each of the bottom four quintiles. In fact, an average effective tax rate above 10 percent emerges only in the top 5 percent (see the first chart)!

One of the worst things about income tax policy of recent years is that so many Americans were dropped off the income tax rolls. Everyone should pay something. Using the income tax to distribute welfare (through the EITC and other refundable tax credits) may be very efficient. But it's corrosive; it engenders a mentality of entitlement. Once folks are put on the dole, they get used to it. Weaning them off welfare is a problem.

Just as we are "defining deviancy down," we are defining dependency up. There's no stigma attached to taking welfare when everyone is on the dole. Obamacare subsides are available to those making up to 400 percent of the Federal Poverty Level. Medicaid is available to more and more. Food stamp usage has exploded. And the bottom half of tax filers contribute nothing in income taxes, which is due, in part, to refundable tax credits (chart) like the EITC. Sound like a tipping point?

Perhaps the main reason reasonable tax reform is unlikely is because our career politicians use taxes to control the masses. They demonize those from whom they take the most and sentimentalize those to whom they give that plunder. The control that taxes give politicians is accomplished with high statutory tax rates and with tons of exemptions, exclusions, exceptions, and refundable tax credits.

What Americans who have incomes but don't pay income taxes need to understand is that it is not only the taxpayers at the top who are paying for them; it's also taxpayers in the bottom half. And some of those taxpayers in the bottom half have lower incomes than the non-taxpayers in the bottom half. If members of Congress want to correct the glaring inequalities they've created, they need to require more middle- and working-class folks to pay at least something in individual income taxes.

We're becoming a nation of takers, not makers. So let's get everybody paying his "fair share." If a 1-percent tax rate is just too high for you, then how about a half-percent?

Jon N. Hall is a programmer/analyst from Kansas City.

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