Fiscal Fact No. 54
With the April 17th deadline for federal tax returns looming, Americans are sharply aware of their 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. 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 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.
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 baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.
.
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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