Under economic pressure, the Obama administration has pursued an
increasingly vigorous class war strategy. At the same time people
continue to be dropped from the income tax rolls. This likely
expands government and increases what the rest of us will have to
pay.
Throughout its early history the federal government didn’t have
an income tax. But a century ago the states ratified the 16th
Amendment. Even then, in its early years the income tax affected
few people. Only during World War II, when up to three-quarters of
the national GDP was consumed by the military, did the income levy
become broad-based.
However, the U.S. is now moving in the opposite direction. A
recent
study by William Freeland, William McBride, and Ed Gerrish for
the Tax Foundation reported that 58 million people, 41 percent of
all tax filers, had no tax liability; indeed, many of them are
receiving money back from the government. Explained the Foundation:
“There are currently more Americans off the tax rolls than at any
time since 1940, when the income tax became a ‘mass tax’.”
Nonpayment results from the expansion of deductions and credits,
including those which are refundable, that is, which generate a
federal check for those who owe nothing. Under 2011 law, noted the
Tax Foundation, a family with an income of $45,000 could end up
receiving $274 after taking the standard deduction, personal
exemption, two child credits, and the Earned Income Tax Credit. The
family also might be eligible for credits for child care,
education, and hybrid vehicles.
In 1950, 28 percent of filers were “nonpayers.” That reflected a
relatively high value of the personal exemption compared to average
incomes. The nonpayers’ share dropped to 16 percent by 1969. It
rose again to 26 percent in 1975, and then dropped until the 1986
Reagan tax reform. Reported Freeland, McBride, and Gerrish, “Since
then, the percentage of tax filers with no income tax liability has
grown dramatically. Indeed, in the twenty years between 1990 and
2010, the percentage of nonpayers nearly doubled, from 21 percent
to 41 percent.”
Related to nonpayers are nonfilers. Millions of people earn
something, but not enough to require them to file a tax form. “By
some estimates, when these nonfilers are added to the number of
nonpayers, the total number of Americans outside the income tax
system jumps to roughly 50 percent of all households,” observed the
Foundation.
Tax reform increased the values of the personal exemption and
standard deduction, which benefited everyone, but especially
lower-wage earners. More recent has been the rapid growth in the
value of tax credits, which directly reduce a filer’s tax
liability. Noted the Foundation: “In 1990, the combined value of
these credits was roughly $20 billion, after adjusting for
inflation. Two decades later, the combined budgetary cost of both
the basic and refundable tax credits reached a remarkable $224
billion in 2010.”
An important reason the credits cost more is that they are
available to more people. Explained the Foundation: “In 2001, the
share of those tax filers between $50,000 and $75,000 with no
income tax liability was roughly one percent. By 2009, that share
had jumped to 12 percent. The threshold at which the typical
married couple with two children will likely be nonpayers given the
standard deduction, personal exemption, and only two dependent
child credits is now roughly $47,000. This is without any
additional deductions or credits, such as the mortgage interest
deduction.”
Of course, nonpayers are subject to other taxes. Indeed, most
low-wage workers pay more in Social Security than in income tax
levies. However, the income tax is the biggest and most visible
source of federal revenue. It also is seen as the chief source of
funds for general government operations, in contrast to others,
such as the payroll tax, which are formally dedicated to particular
purposes (even though, in practice, money is fungible). People seem
most likely to measure the personal cost of government by their
income tax liability.
If government spending were going down, we might celebrate the
rise of nonpayers. Reducing the number of people subject to the
burdensome and intrusive income tax would be an unabashed good.
However, government expenditures have been rising steadily and
rapidly. Real, inflation-adjusted outlays jumped 58.4 percent
between 1980 and 1990. They “only” increased 28.2 percent during
the 1990s. They went up almost exactly the same amount during the
first decade of the 21st century. It certainly appears that more
people perceive government as an essentially free good as a result
of what is commonly called the “fiscal illusion.” Explained the Tax
Foundation:
Basic economic theory tells us that consumers will respond to a
drop in the price of a product by demanding more. By extension,
economists predict that as the price of government goes down for a
citizen, he or she will then demand more of it. When the cost of
government is shifted away from a citizen through deficit spending
or progressive taxation, this creates disproportionate demand.
Yet satisfying this demand is likely to slow economic growth.
The Foundation recognized the argument that expenditures on
education and infrastructure may yield an economic benefit, but
observed:
“[T]ransfer payments can retard economic growth because they
redistribute income from working individual to non-working
individuals. Numerous studies suggest that as transfer payments and
their accompanying taxation grows, a nation’s economic growth
potential and employment opportunities suffer.”
Does the rise of nonpayers encourage increased outlays? The Tax
Foundation reviewed federal spending and taxing from 1950 to 2010
and found only a weak correlation. As the Foundation noted: “total
government spending grew steadily over the 60 year time period we
considered, while the percentage of nonpayers fluctuated
considerably.” It appears that the overall bias toward government
growth essentially swallowed much of the impact of the growing
number of nonpayers.
However, the Foundation discovered a stronger relationship
between nonpayers and transfer payments. Noted the Tax Foundation:
“After the late 1960s, with the start of the Great Society
programs, the growth of transfer payments and the growth of
nonpayers begin to move closer together. For example, the
percentage of nonpayers spiked in 1975 to nearly 26 percent. This
spike corresponds to a sharp increase in transfer spending. Over
the past 25 years, the two trends seem to track each other quite
closely, with both reaching their 60 year peak in 2009 and
2010.”
The Foundation figured that every one percent increase in the
share of nonpayers corresponded to an increase of $10.6 billion in
transfer payment outlays. The money adds up. Explained the report:
“Since the number of nonpayers has increased by 20 percentage
points over the last two decades, this model implies that in 2010
alone, almost $213 billion in higher transfer payments resulted
from the growth of nonpayers over the last two decades. This
represents nine percent of the total $2.287 trillion spent in
transfer payments that year.” Stripping out Social Security and
Medicare do not change the relationship, but only cut the estimated
annual increase to $9 billion.
No such association was evident for non-transfer payments.
Although that would seem counter-intuitive, the authors posited
that “non-transfer payment spending does not go directly into the
hands of the voters. Instead, this spending is often composed of
indirect investments and the benefit from this spending is widely
dispersed among all voters.” Moreover, perhaps these outlays have
hit the point of diminishing returns, and thus voter demand has
fallen. Or perhaps overall budget constraints exist and have placed
transfer and non-transfer payments in competition, with the former
emerging victorious.
The Foundation also found a positive correlation between
nonpayers and federal debt. For every one percent increase in
nonpayers as a share of filers, the debt/GDP ratio rises .704
percent. “This implies that the 20 percentage point increase in the
share of nonpayers over the last 20 years has increased the debt
ratio by 14 percentage points.” Such a rise logically follows the
increased demand for transfer payments when taxpaying voters seem
increasingly averse to higher taxes.
In Washington today the greatest concern over nonpayers is lost
revenue. However, the underlying problem is that government spends
too much, not that it collects too little. Unfortunately, noted the
Foundation, “we are now seeing the fiscal cost of dropping millions
of Americans from the income tax rolls in the form of record levels
of federal transfer spending and national debt.”
Thus, despite the obvious appeal in further reducing the tax
rolls, the Foundation’s “findings imply that when voters perceive
the cost of government to be cheaper than it really is, they demand
ever more government benefits because they either don’t feel the
cost directly or believe that others will be paying those costs.”
Which means meaningful tax reform should address the problem of
nonpayers.
The Foundation concluded with a call for “a more balanced tax
burden.” The wealthy already pay the vast majority of income taxes.
According to the Congressional Budget Office, the total share of
income tax liabilities paid by the top one percent of households
ran 39.5 percent in 2007 (the CBO’s latest figures). The top five
percent paid 61.0 percent of all income taxes. The highest earning
ten percent were responsible for 72.7 percent of income tax
collections. (The same groups also pay the bulk of corporate and
social insurance taxes.) It simply isn’t possible to fund the
welfare state by extracting more money from those who already are
paying the bulk of the bill.
Especially since the attempt to do so likely would further
inflate federal outlays. Concluded the Foundation: “so long as
income taxes fund the largest part of government spending,
exempting half the population from income taxes is not a
sustainable fiscal model. Debt accumulation and eventual default
await those democracies that fail to connect a majority of voters
to the cost of government spending.”
Reconnecting voters may be the most important objective of tax
reform. Reducing rates and simplifying administration are
important. But ensuring that all Americans have a financial stake
in paying for general government operations, and especially
transfer payments, may be most vital.
