Why Half of Americans Don't Pay Federal Income Tax

Why Half of Americans Don't Pay Federal Income Tax

The political news cycle exploded this week when Republican presidential candidate Romney was caught, in a secretly-taped fundraising event, telling wealthy potential donors what he thought about the tax system.

“There are 47% of the people who will vote for the president no matter what,” Mr. Romney said. “There are 47% who are with him, who are dependent upon government, who believe that they are victims, who believe the government has a responsibility to care for them, who believe that they are entitled to health care, to food, to housing, to you-name-it, that that’s an entitlement. And the government should give it to them. And they will vote for this president no matter what. These are people who pay no income tax. My job is is not to worry about those people. I’ll never convince them they should take personal responsibility and care for their lives.”


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Whoa, what a scandal!

Or not, depending on who you ask. Romney's statement has morphed into a sort of Rorschach test for how you think about the tax system. Are entitlements out of control? Are lazy Americans truly sucking the system dry? Or is this just a sign of hard economic times and the result of Bush-era tax cuts?

With all the facts that are being bandied about in the media, we've decided to give you the economic and policy background behind them, and then let you decide what you think of his remarks. We'll cover Romney's assumptions in his speech, plus responses by liberal pundits.

Seriously, after reading this article, you are going to be so ready to debate that insufferable friend of yours who's on the opposite side of the political spectrum.


Before we get started, we should warn you: The federal tax system is extremely complicated (you know this). In order to break down how it has led to 47% of households paying no federal income taxes, we'll have to use some terms that you have no reason to be familiar with outside of tax time during April. So we've created definitions that will pop up when you mouse over the underlined words and link to articles explaining these terms further that you can explore if you are confused or would like to know more. For a basic explanation of how taxes work, you can read this short article.

Before we begin, let's be clear about what Romney was talking about: federal income taxes. These are taxes levied by the federal government on whatever income you make, including your salary, income from investments, freelance income, income from your business and many other types of income.

OK, let's dive into the facts:

“There are 47% of the people who will vote for the president no matter what ... These are people who pay no income tax."

QUESTION: Is this true?

ANSWER: Yes, 47% of Americans pay no federal income tax.

Romney was accurate: 47% of Americans don't pay federal income tax. These households who don't pay federal taxes aren't off the tax rolls because they are running from the IRS or taking advantage of the system. The tax system is just set up this way, and they are doing what any taxpayer--including you--would do. They are taxed on a certain percentage of their income, but they receive a combination of deductionsDeductions subtract from your taxable income. That means for each deduction, the amount of income you're taxed on goes down, meaning you pay a little bit less in taxes. , creditsCredits reduce the amount of taxes you owe. So if you receive a $1,000 credit, that means you will pay $1,000 less in taxes.  and exemptionsExemptions reduce the amount of income you will be taxed on. For each exemption you took for 2011, you could deduct $3,700 from your gross income to arrive at your taxable income. So if you fell in the 10% tax bracket, that translated to $370 less in taxes. You are allowed to take an exemption for yourself (“personal” exemption), your spouse and each dependent. that bring their tax bill down to $0. In fact, they don't even need an accountant to figure that out, they just need to follow the steps on the basic 1040 form in April.

Q.: Are these people paying any taxes?

A.: Yes, the vast majority are.

Two-thirds of households who don't pay federal income tax, pay other taxes, such as payroll taxes--which are what get taken out of your paycheck for Social Security and Medicare. And Americans also pay federal taxes on alcohol, gas and cigarettes. Overall, just 10% of households pay no net federal taxes. And then there are state and local taxes that we pay, too. In order to not pay any taxes at all, you would have to completely opt out of our economic system (like Freegans)--otherwise, you're paying sales tax on your purchases at least.

Q.: Who are they?

ANSWER 1: Four out of five households who pay no federal income tax earn less than $30,000.

One of the biggest reasons households don't pay federal income tax is because of limits on taxes for low-income earners. After these households take the standard deductionMost people take the standard deduction on their returns, which is worth anywhere from $5,800 to $11,600. This means if they make $20,000 and take the standard deduction, they could pay taxes on only $14,200 in income., plus personal exemptions for themselves and their dependentsLoosely defined, a dependent is a child or family member who doesn't have significant income of their own and relies on you for shelter and other living expenses.--which all subtract from their tax bill--they end up not owing anything.

ANSWER 2: 44% of households paying no federal income tax are the elderly.

Many of those not paying federal income taxes are receiving Medicare and Social Security benefits, and depending on their income, retired households pay a lower tax rate on Social Security benefits and don't pay taxes for the value of Medicare. In addition, people over 65 get a larger standard deduction, and a credit for the elderly depending on their income. The elderly also often have high medical expenses, which can be deducted. (By the way, in polls, Romney looks to grab 53% of the elderly vote, while Obama currently has anywhere from 38 to 45% of the elderly vote.)

ANSWER 3: And about 7,000 of the households paying no federal income tax include millionaires.

Not everyone not paying income taxes is the low-income or the elderly. The very wealthy make up a small percentage of this group as well. There are essentially three reasons why someone who has a high net worth could pay zero in taxes. They a) could have engaged in creative accounting, which usually requires an accountant on retainer, complicated assets and perhaps an off-shore bank account, b) could have taken advantage of lower tax rates on investment income, c) could have suffered a huge financial misfortune (illness or catastrophic damage to their home, both things that could happen to anyone) which allowed them to deduct large amounts from their tax liability or d) it could be some combination of these factors. Since we don't have a breakdown of the reasons why these millionaires didn't pay, we can't assume they are or aren't playing the system. This one, for now, is a black box.

"There are 47% who are with him, who are dependent upon government, who believe that they are victims, who believe the government has a responsibility to care for them, who believe that they are entitled to health care, to food, to housing, to you-name-it, that that’s an entitlement. And the government should give it to them."

Q.: Are the rich supporting tax breaks for lower-income households?

A.: Tax breaks actually benefit high-income individuals more than low-income individuals.

High-income tax payers receive a higher percentage of their income--and a higher amount of money overall--in tax breaks. There are several reasons for this. High-income individuals are more likely to be covered by insurance and pension plans through their employers, to which contributions are tax-free. The lower tax rates on investment income disproportionately benefit the top 1% of earners. Higher-income tax payers receive more gains from itemizing their deductions, while lower-income earners just take the standard deduction. And lower-income taxpayers rarely take advantage of middle class-centric deductions for student loans, higher education expenses and self-employed medical insurance premiums.

This is partly due to the fact that some of Bush's tax cuts in 2001 and 2003 were mostly beneficial only for the wealthy (and middle class, as we'll explain below). Bush's tax cuts lowered capital gains taxes (taxes on the income you earn from investments) and the tax rate on dividend income (which also comes from investments). They also eliminated the estate tax (which affects those who leave assets to their children) and the provision that would keep high-income taxpayers from taking personal exemptions and itemized deductions.

"And they will vote for this president no matter what."

Q.: Are people not paying federal income tax and relying on government benefits leaning toward voting for Obama?

A.: Not always.

Out of the ten states with the highest proportion of non-federal-income-tax-paying households, eight are Republican states. This statistic--which has been cited across the blogosphere, complete with this handy red/blue state map--can be rather misleading, as it implies non-payers are more likely to vote Republican, which isn't always the case. Low-income earners are more likely to vote Democratic, even in states that went Republican in the last presidential election. In the 2008 election, 75% of voters earning less than $15,000 voted for Obama, and 63% of those earning $15,000 to 30,000 did. On the other hand, the elderly, who as we pointed out earlier are some of the people not paying federal tax, leaned Republican: 53% voted for McCain.


Another way to look at this red-state-blue-state phenomenon is through the lens of government spending. In his speech, Romney lumped people who don't pay federal income tax in with people who depend on government benefits, but they are not always one and the same. As we stated above, most households not paying income tax are low-income or elderly citizens. These two groups do benefit from government spending (hello Medicare and food stamps) but they aren't the only ones. In 2007, the bottom fifth of households by wealth only used 36% of government benefits. The rest mostly went to middle-class families. In fact, states where the federal government spends more on entitlement programs, like unemployment and subsidized school lunches, than they collect in taxes are actually more likely to lean Republican. The IRS is taxing people living in these states at the same rate as the rest of the country, but the government is doling out more benefits.

Q.: Who is most recently responsible for these people not paying federal income tax?

ANSWER 1: 7.8 million families stopped paying federal income tax because of Bush tax cuts.

Romney seemed to imply that Democrat-enacted programs were responsible for people not paying federal income tax. But Bush's tax cuts in 2001 and 2003 enacted a few provisions that were responsible for pushing some families out of the tax rolls completely. They lowered federal income tax rates for everyone and doubled the child tax credit from $500 to $1,000 per child. In this example, a married couple with two children earning $40,000 in income would have paid about $2,158 in 2000. After the tax cuts in 2004, they would have taken a larger standard deduction, a larger personal exemption, and received a child tax credit that was twice as large, bringing their taxes to ... $0. Most of the families that benefited from these tax cuts earn less than $50,000 a year (90%) and work full-time or part-time (91%). This amounted to about $1.5 trillion in tax cuts--$2.8 trillion if you include the extension of them under Obama.

altANSWER 2: And 95% of working families and individuals received tax cuts under Obama's stimulus plan.

Obama was also responsible for ensuring that some people wouldn't have to pay income tax. The tax cuts included in the stimulus included a refundable credit of up to $400 per working individual and $800 for working married couples and a temporary increase of the earned income tax credit (EITC) for low-income families. This amounts to $218 billion in tax cuts.

ANSWER 3: But the percentage of people not paying federal income tax has been rising since the 60s.

Reagan enacted policies that lowered lowered tax rates for everyone by double digits percentage points. In fact, you can see him discussing in this video how his policies would make it so that fewer low-income and disabled people would have to pay federal taxes. Overall, you can see the rising percentage of Americans not paying federal income taxes over the past fifty years in the chart to the right.

What Do You Think?

Now that we've laid out the facts, we know you have an opinion ... or some more facts of your own to add. Is it OK that 47% of households don't pay federal income tax? Or does this signal a deep-rooted economic problem in America? And if so, who's fault is it? Tell us your thoughts in the comments.


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