On July 14th, the IRS held a public hearing for the debt-equity rule (section 385 of the IRS code) that the Treasury Department proposed last April. The hearing, which had as many as 16 speakers from various industries,...
- What Are the Fiscal Costs of Nonpayers?
What Are the Fiscal Costs of Nonpayers?
Shrinking Pool of Taxpayers Linked to Greater Government Spending, Debt
Washington, D.C., September 20, 2012— As of 2010, 41 percent of tax filers—some 58 million in all—had no income tax liability after taking their credits and deductions. When one adds the number of Americans who do not file a federal return, about half of all households pay no federal income tax, more than at any time since 1940, according to a new study from the Tax Foundation.
Aside from the revenue impact of so many Americans not paying income taxes, economists worry about the social and political effects of having so many people disconnected from the cost of government—a phenomenon known as “fiscal illusion.” When individuals perceive the cost of government to be cheaper than it really is, they tend to demand ever more government benefits.
“We find that the growth of nonpayers is strongly associated with increases in spending on federal transfer payments,” said Tax Foundation economist Willian Freeland. “A one percentage point increase in the share of tax filers who are nonpayers is associated with a $10.6 billion per year increase in transfer payments. Since the number of nonpayers has increased by 20 percentage points over the last two decades, our model indicates that in 2010 alone, over $213 billion in transfer payments are associated with this increase in nonpayers.”
The increase in nonpayers may also be affecting the national debt. The Tax Foundation’s analysis finds that for every one percentage point increase in the share of tax filers who are nonpayers, the debt as a percentage of GDP increases by 0.7 percentage points. For example, if the percentage of nonpayers increased from 40 percent to 41 percent, the debt held by the public to increase from 70 percent of GDP to 70.7 percent of GDP. This means that the debt ratio has increased by 14 percentage points since 1990 due to the increase in nonpayers.
The fiscal cost of dropping millions of Americans from the income tax rolls are now being seen in the form of record levels of federal transfer spending and national debt. As lawmakers consider proposals for tax and entitlement reform, they should take into account the fiscal impact of exempting a majority of Americans from the largest source of federal tax revenue.
“The dire fiscal straits we are now in, and which much of Europe is struggling with as well, can only be responsibly addressed through a more balanced tax burden,” said Tax Foundation Chief Economist William McBride. “In particular, 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.”
The Tax Foundation is a nonpartisan research organization that has monitored fiscal policy at the federal, state and local levels since 1937. To schedule an interview, please contact Richard Morrison, the Tax Foundation’s Manager of Communications, at 202-464-5102 or email@example.com.
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