Sunday, October 2, 2011

Who are the 50% that don't pay taxes

The GOP has begun talking about half of all Americans that don't pay tax.  First, lets clarify that when they say "don't pay tax", they mean they don't pay federal income tax.  They still pay payroll taxes (social security and medicare, etc.) directly to the federal government.  In addition they pay state tax, local income tax, and sales taxes.    Lastly, the number is actually 46%, as per the Tax Policy Center.   But lets talk about that 50% that don't pay 'federal income tax'.

(My source)
First of all, about a one third  of the "no taxers" made $20,000 or less a year.  That is less than 1700 a month.   The issue should not be that many Americans don't pay tax, it should be that 15 % of Americans make less than $20,000 a year.  That is families making less than $20, not each parent.  About 6% of Americans don't even make $10k a year.

Second, it's not quite as bad as that sounds - because about a lot of those people are not working and we don't expect them to be working.  Some are elderly and some are students.  Specifically, 44% of the 'no taxers' get the various Elderly credits in the code.  That is, they are retired or mostly retired senior citizens, getting social security.

Another 5.6% of the 'no taxers' get education credits, so they are most likely full time students or paying for kids in college..  Another 30.4% of the 'no taxers' are getting the credits for Children & Working poor.  That is, they are making very little money - about $20,000 a year or less, and/or have children.

That leaves about 20% of people that are not elderly and not poor, but manage to pay no taxes.  Some of that is from severe health issues - often temporary.  You can avoid paying taxes for workers comp, disability, etc.  That works out to about 6% of the 'no taxers'.

You end up with a about 15% of no-taxers doing it the hard way.  Remember, no- taxers are about 50% of the entire population, so that is about 7.5% of Americans paying no taxes without being old, very poor, paying for school, or getting disability.   They use itemized deductions, such as mortgage interest, charitable contributions, business losses, gambling/stock losses, and tax-exempt bonds to avoid paying federal income tax. 

Of these 15%, two thirds (about 10% of the 'no taxers, about 5% of the entire population) are middle class (making between $50-$100k). The $50-$100k group is harder to define, as it includes seniors that invested wisely and people with large families barely making it and not paying taxes because they have 7 children.    It may also consist of people paying no tax in one particular year because of special circumstances.  I am talking about - business upsets, theft, etc.  If you normally make $100k a year, but this year your house gets destroyed by flood and you have no insurance, that can eliminate your tax bill.    Or if your long term business, which used to make $200k a year did horribly and you earned only $75k, then business losses could eliminate your tax bill.

Only 1/3 (5%) of 'no taxers' make more than $100,000 a year. Again, that is 1/2 the entire population, so about 2.5% of Americans make more than $100,000 and are not old/poor/paying for school/or getting disability.  These are the people that it is truly surprising that they don't pay federal income taxes.
 The statistics show they tend to use the same methods as the middle class. The two biggest cause for "rich people paying no taxes" appears by far to be most of their income being Tax Exempt (municipal bonds, foreign earnings etc.) and Itemized Deductions.  In the Itemized Deductions, the biggest one by far is the mortgage credit.

Full disclosure: I own a home and take full advantage of the Mortgage credit and it does lower my federal income tax a lot - but not to zero.  I still pay significant federal income taxes.  But if I were to have four children with a stay at home wife (or worse, a wife going to school part time), plus take some capital losses in stocks then I might be able to avoid all federal income taxes.  Or if I were 65 living off of my savings plus social security, with the same mortgage I have now, I could see not paying any federal income tax.

Honestly, entirely removing the deductions that those 2.5% of Americans use - Mortgage and Tax Exempt interest - would be a bad idea.  It would affect a lot of the middle class, destroy housing prices, and hurt a lot of people.  But if you start to phase them out, with limits of no more than X dollars, that would be reasonable.
We tried that already it's called the "AMT" and most people consider it a failure. 

Even if we re-vamped the AMT to make it work right, don't expect a huge benefit from limiting the mortgage deductions or reducing the tax exempt status of bonds.  The blow to high end real estate and to states trying to raise funds with bonds would probably more than offset any gains.

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