Refundable Tax Credits Give the Bottom Two Quintiles Negative Effective Tax Rates

November 13, 2013

About half of all nonpayers receive refundable tax credits even though they have no income tax liability. This means that, in addition to recouping every dollar withheld from their paycheck during the year, they also receive a subsidy check from the IRS. The Congressional Budget Office now estimates that, because of the large amount of refundable tax credits, the bottom 40 percent of households now have negative effective tax rates. Remarkably, the effective tax rate for middle-income households is nearing zero because of the recent expansion of tax credits. The net effect of these trends is that virtually the entire income tax burden is now being borne by the two highest groups of taxpayers.

For more charts like the one below, see the second edition of our chart book, Putting a Face on America's Tax Returns.

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A 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.

A 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.

A 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.