Number of Americans Paying Zero Federal Income Tax Grows to 43.4 Million

 
 
March 30, 2006

Fiscal Fact No. 54

With the April 17th deadline for federal tax returns looming, Americans are sharply aware of their federal income tax liabilities. However, one aspect of federal income taxes they may not be aware of is the growing number of Americans who pay zero federal income tax after taking advantage of deductions and credits.

During 2006, Tax Foundation economists estimate that roughly 43.4 million tax returns, representing 91 million individuals, will face a zero or negative tax liability. That's out of a total of 136 million federal tax returns that will be filed. Adding to this figure the 15 million households and individuals who file no tax return at all, roughly 121 million Americans—or 41 percent of the U.S. population—will be completely outside the federal income tax system in 2006.1 This total includes those who pay no tax, and those who pay some tax upfront and are later refunded the full amount of the tax paid or more.

Who Are the Non-Payers?
Using IRS data, we are able to create a profile of these individuals who are outside the federal income tax system. As Table 1 shows, those who file as single or head-of-household are much more likely to be non-payers. One-third of single filers pay nothing in federal income taxes, and almost two-thirds of those who file as head of household pay nothing. In contrast, just 22 percent of married filers are non-payers.

Why do many single filers face zero tax liability? One reason is that single filers tend to be younger and earn lower incomes than married filers—especially single parents who file as head-of-household. As a result, married taxpayers pay roughly 75 percent of all federal income taxes, despite filing only 40 percent of returns.

Table 1. Projection of Filing Status of Non-Payers, Tax Year 2006  

Filing Status

Percent of Returns in Filing Status That Are Non-Payers

Percent of All Non-Payers Who Are in Filing Status

Single

33.1%

42.2%

Married filing jointly

21.5%

29.8%

Married filing separately

21.6%

1.2%

Head of household

65.7%

26.6%

Source: Internal Revenue Service, Tax Foundation.

Non-Payers by State  
The number of Americans who face zero federal income tax liability varies widely by state. Table 2 illustrates the number of projected non-payers for 2006 by state. There are two primary reasons why some states have a disproportionate share of non-payers. First is that average household income varies by state, and those with lower-than-average incomes will have a larger share of non-payers. Second, some states have a high number of single parents—who typically file as head-of-household—whose tax liabilities are reduced through tax credits such as the $1,000 per child tax credit and the Earned Income Tax Credit. The estimates in Table 2 do not take into account the likely increase in the number of non-payers in Gulf Coast states as a result of Hurricanes Katrina and Rita.

Table 2. Residents of Some States are More Likely to Pay Zero Federal Income Tax than Others (2006 Estimate) 

  Number of Returns Filed Returns with Zero or Negative Tax Liability Percentage of Returns in Each State with Zero or Negative Tax Liability Rank by Percentage of "Non-Payers"
U.S. Total 135,660,228 43,362,718 32% -
         
Alabama 1,945,483 734,157 38% 5
Alaska 354,271 71,740 20% 50
Arizona 2,360,197 776,590 33% 18
Arkansas 1,158,262 439,675 38% 3
California 15,668,908 5,105,168 33% 20
Colorado 2,147,160 613,696 29% 35
Connecticut 1,707,972 408,945 24% 48
Delaware 401,010 105,916 26% 44
Florida 8,106,717 2,782,600 34% 13
Georgia 3,830,840 1,363,353 36% 10
Hawaii 610,450 177,201 29% 32
Idaho 596,861 209,808 35% 12
Illinois 5,910,250 1,810,128 31% 26
Indiana 2,908,813 885,744 30% 27
Iowa 1,368,283 393,833 29% 34
Kansas 1,258,504 393,007 31% 24
Kentucky 1,797,892 599,028 33% 17
Louisiana 1,941,234 777,004 40% 2
Maine 635,244 182,943 29% 33
Maryland 2,687,104 696,489 26% 45
Massachusetts 3,151,680 749,325 24% 49
Michigan 4,695,299 1,411,601 30% 28
Minnesota 2,461,914 630,657 26% 46
Mississippi 1,207,967 516,757 43% 1
Missouri 2,647,896 834,018 31% 22
Montana 447,726 162,773 36% 7
Nebraska 829,008 253,951 31% 25
Nevada 1,078,230 306,409 28% 36
New Hampshire 655,447 157,466 24% 47
New Jersey 4,215,850 1,148,262 27% 39
New Mexico 840,391 318,744 38% 4
New York 8,871,365 2,838,370 32% 21
North Carolina 3,801,408 1,299,289 34% 14
North Dakota 312,334 92,486 30% 30
Ohio 5,622,504 1,588,793 28% 37
Oklahoma 1,508,808 547,112 36% 8
Oregon 1,623,370 510,012 31% 23
Pennsylvania 5,960,865 1,760,123 30% 31
Rhode Island 514,381 136,883 27% 42
South Carolina 1,863,934 667,601 36% 9
South Dakota 369,160 121,027 33% 19
Tennessee 2,649,084 901,139 34% 15
Texas 9,603,456 3,575,431 37% 6
Utah 1,001,586 354,270 35% 11
Vermont 312,110 87,224 28% 38
Virginia 3,544,201 945,257 27% 41
Washington 2,900,573 771,846 27% 43
West Virginia 768,830 260,437 34% 16
Wisconsin 2,674,696 714,104 27% 40
Wyoming 248,894 74,394 30% 29
D.C. 284,676 80,853 28% -

Note: Figures do not take into account the likely increase in Gulf Coast non-payers resulting from 2005 hurricane damage.
Source: Internal Revenue Service, Tax Foundation.

Large Number of Non-Payers Make Tax Reform Difficult
Federal tax reform requires that the base of the federal income tax be widened, so that overall tax rates can be reduced. However, because of the large number of Americans currently paying zero federal income tax, any attempt to broaden the tax base will be a difficult sell for lawmakers. The millions of Americans who have no federal income tax liability will either be indifferent about tax reform or will positively oppose it, as it would require bringing them into the federal tax base.

The Effect of Recent Tax Cuts on Non-Payers
As President Bush pushed through his two major tax bills in 2001 and 2003, opponents focused on the dollar amounts saved by high-income individuals. What many critics have ignored is the number of people who were removed from the tax rolls as a result of the expansion of the child tax credit, which was a key provision of the President's Economic Growth and Tax Relief Reconciliation Act of 2001.

As Figure 1 illustrates, the number of tax returns with zero or negative tax liability has risen steadily over the past decade. However, it accelerated sharply between 2000 and 2004 due to the effects of tax changes during President Bush's first term of office. (For a detailed demographic profile of "non-payers," click here.)

Figure 1. Percent of Tax Returns with Zero or Negative Tax Liability, 1950 to Present

Source: Internal Revenue Service, Tax Foundation. 

Conclusion
These findings raise serious questions about the future of the U.S. income tax system, and the possibility of base-broadening tax reform when the majority of the federal tax burden is borne by a shrinking pool of taxpayers. As Congress considers tax reform proposals during the coming year, this is an issue lawmakers should begin to debate.

Footnotes
1. Those who are claimed as dependents on a tax return with positive tax liability are defined as “in the tax system.”

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