There’s been a lot of political rhetoric and, consequently, media coverage about Americans who pay no federal income taxes.
Republican presidential hopeful Mitt Romney was surreptitiously recorded as writing off the support of what he said was the 47 percent of Americans who don’t pay federal income taxes nad have become dependent on government assistance with health care, food and housing. President Barack Obama has countered that Romney should “come clean” on his own tax returns and noted that Romney paid a lower tax rate than many other Americans. Obama continues to argue as well the rich should “pay their fair share” in taxes.
As is usually the case with presidential politics, rhetoric trumps reality. Nonetheless, the latest debate over who pays federal income taxes and how much raises important issues related not only to the progressive tax system in place in the United States, but the connections between tax policies and government spending and debt.
For starters, it’s important to note that not all of the Americans who don’t pay federal income taxes are deadbeats living off government benefits. Many are hard-working members of families who receive enough deductions and credits to offset the tax liability on the income they earn. In fact, most of those who don’t pay income taxes still pay payroll taxes that fund Social Security and Medicare. The ranks of those who don’t pay income taxes also include the elderly. And, yes, there are some rich people who manage to escape tax liability.
As for Romney paying a lower tax rate on his income than other Americans, that’s because he’s paying taxes on investment earnings, which are taxed at a lower rate than wages. That’s a function of the tax code. Keep in mind, too, that people already have paid taxes on income that’s invested, then pay taxes again on the gains those investments return. And enough already of the ridiculous notion the rich somehow don’t pay their fair share of taxes. We’re not even talking about millionaires and billionaires. Under the progressive tax system, those who earn over $100,000 per year pay about 70 percent of all U.S. taxes.
There’s yet another important consideration, and that has to do with the disconnection between taxes and government spending — a phenomenon known as fiscal illusion. When people don’t pay federal income taxes, they perceive the cost of government to be cheaper than it really is and tend to demand more government benefits.
A recent study conducted by the Tax Foundation suggests that for every 1 percent increase in the proportion of federal income tax filers who don’t pay taxes, there’s a $10.6 billion increase in transfer payments — that is, payments to programs that offer direct assistance through unemployment insurance, Social Security, Medicare, Medicaid and food stamps. As the proportion of nonpayers has increased 20 percent over the last two decades, transfer payments have increased $213 billion. The study also found that for every 1 percent increase in the share of nonpayers, federal debt as a proportion of gross domestic product increases seven-tenths of a percent. That same 20 percent increases in nonpayers translates into a 14 percent increase in federal debt as a proportion of GDP.
Besides arguing about who and who doesn’t pay taxes and how much, the debate also should include proposals to change tax policy so that more people have some skin in the game.