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Friday, July 29, 2011

People who pay no income tax - persepctives

The Tax Policy Center has an interesting and informative post - "Why Do People Pay No Federal Income Tax?" (7/27/11). It notes that a family of four with income of $26,400 will pay no federal income tax in 2011 due to the standard deduction and four personal and dependency exemptions. Hopefully few people are concerned about this other than perhaps that the standard deduction should be higher. Despite this family owing no federal income tax (and probably no state income tax either), they have paid payroll taxes, sales tax, excise taxes and some portion of the corporate income tax. Most likely at least 20% of their income is paying taxes of some type.

The Tax Policy Center post goes on to help explain why those making more than $26,400 and up to $50,000 pay no federal income tax. For that group, it is due to tax expenditures (the standard deduction and exemptions are not tax expenditures as an income tax should exempt some minimal amount to leave money to live on). Key tax expenditures for this group are elderly benefits and the child credit (see the pie chart in the post).

I am glad to see the Center note that the tax savings in this group pale in comparison to the tax savings those with much higher income gain from lowered tax rates and an even larger group of tax expenditures available to them.

My example: How much federal income tax should a taxpayer with $50,000 of income pay? I'd think no more than 10% (and really less given the other taxes they pay). But assuming 10%, that is $5,000 of tax. Current tax expenditures likely prevent such a taxpayer from paying most of that $5,000. Consider someone with at least $100,000 of capital gain income. Today, at a 15% capital gain tax rate (rather than 20%), they save $5,000 of tax (and likely live far more comfortably than the individual or family with $50,000 of income. Or better yet, if a person had only $20,325 of qualified dividends, they would save $5,000 of taxes (difference between current tax of 15% and 39.6% maximum rate without the tax cuts in place).

The tax savings of lowered rates on ordinary income and much lower rate on dividends and lower rate on capital gains, in addition to other tax expenditures (such as itemized deductions and the exclusion for employer-provided health insurance), means that higher income individuals have greater tax savings. That is, focusing on the tax savings of someone with $50,000 of income while ignoring the tax savings that for those with very high incomes are much greater than that person's income, is missing a big part of the tax cut and tax expenditure debate.

Let's focus on how much we think people at different income levels should pay and how to design a simple, equitable and efficient tax system to reach that point.

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