My colleague Will McBride has already written about the Mitt Romney video everyone’s talking about, but I wanted to touch on another aspect of the “nonpayers” phenomenon at the center of the controversy.
What does it mean to be a “nonpayer” when it comes to the federal income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. ? The standard definition that we and others use is someone whose income tax liability is zero or negative. The main thing driving the growth of nonpayers is the recent expansion of refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit. s such as the EITC and the child tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. . (It’s worth noticing that both parties share responsibility for this: the Bush tax cuts doubled the child tax credit and expanded the EITC for married filers, and the 2009 stimulus bill further expanded both credits.) The size of these credits often exceeds the amount of tax owed by low income filers, and because they are “refundable,” they receive a check from the IRS for the difference.
Figure 1. Child Tax Credit Parameters
|Amount Per Child||$1,000|
|Refundable Portion||Up to 15% of Adjusted Gross Income Over $3000|
|Starts Phasing Out At||Single Filers: $75,000|
|Married Filers: $110,000|
Figure 2. EITC Amounts (2011)
One of the problems with these kinds of tax credits is that they muddle the separation between who pays taxes and who doesn’t. For example, just because a family receives a tax credit worth more than their tax liability, that doesn’t mean they don’t pay income tax at all – after all, their taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. and tax liability before credits could still easily be positive, and so changes in tax rates would affect them in a material way (by changing the size of the check they ultimately get back.) Furthermore, these credits cause people to become “nonpayers” specifically because they are implemented through the tax code and not as a direct spending program. If the child tax credit were instead implemented by having a federal agency write every family a check for $1000 per child every year (while phasing out the benefits at higher incomes) the ultimate effect would be more or less the same as the status quo (despite the reduction in the nominal number of “nonpayers”) and done entirely outside the tax system. Furthermore, even when such credits don’t exceed tax liability, calling these things “tax credits” reduces transparency by disguising government spending as foregone revenue.
Another, more expansive definition of someone who pays income tax is someone whose marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. is positive– in other words, the effective tax rate on his or her “top dollar” of income is greater than zero. High marginal rates can lead to a perception that one’s tax burden is greater than it actually is; for example, a single mother of two earning $32000 is a “nonpayer” in the sense that the amount of credits she receives is greater than her tax liability. However, her taxable income is positive, and she’s also in the range where her earned income credit phases out. Add payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. es to that and you get a marginal rate of almost 42%. In other words, if she were to receive a $1000 raise, her after-tax incomeAfter-tax income is the net amount of income available to invest, save, or consume after federal, state, and withholding taxes have been applied—your disposable income. Companies and, to a lesser extent, individuals, make economic decisions in light of how they can best maximize after-tax income. would only increase by $580. (This sort of thing is likely why polls show that well over 53% of Americans think their tax rate is too high despite only 53% paying any income tax.) Under this definition, “nonpayers” are those people whose marginal tax rate is zero (or even negative.)
Some people would dispute this narrow definition of nonpayer because they don’t consider the phase-out of a cash benefit to be a tax. So a third, slightly more expansive way to define “nonpayer” would be someone whose taxable income is positive – someone whose income exceeds their standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. and personal exemptions. This definition has the advantage of classifying everyone who is affected by changes in statutory tax rates (that is, people with “skin in the game”) as a payer, and everyone who isn’t as a nonpayer.
I’ve created a small calculator widget (using 2011 tax law) below to show the differences between these definitions. You can enter in a filing status, income, and number of children, and determine if the household is a nonpayer under any of the three definitions above.