Lucky enough to pay taxes

September 21, 2012

“People. People who pay taxes, Are the luckiest people in the world …” That may not be exactly how the lyrics, most memorably sung by Barbra Streisand in the musical “Funny Girl” actually go, but one could argue that one is lucky to be well off enough to pay federal income taxes.

A research note from Stone & McCarthy Research Associates economist Nancy Vanden Houten wonders why “obsessing about taxpayers with no federal income tax liability” has become a focus of the U.S. presidential campaign.

We think the emphasis is misplaced. A more appropriate question to ask is how much all taxpayers benefit from provisions of the tax code.

And the answer to that, she observes, is that America’s rich are net winners from the current tax structure.

Upper income taxpayers benefit more from tax expenditures, in absolute dollar terms and as a percentage of income.

The 47 percent figure Republican Presidential nominee Mitt Romney cited as the portion of the people who pay no income tax appears to be based on estimates from the Tax Policy Center (TPC) released last year, Vanden Houten writes. According to TPC estimates, 78.5 percent of taxpayers with no federal income tax liability in 2011 had incomes of less than $30,000. But the details are more nuanced:

There are taxpayers in upper income brackets who also had no tax liability. The reasons taxpayers don’t pay federal income tax vary. Some households have no liability simply because of progressive provisions of the tax code like the standard deduction and personal exemptions. Other taxpayers have their liability eliminated through so-called tax expenditures.

That’s why focusing on how pays taxes and who doesn’t can be misleading.

We think it’s more appropriate — especially if policymakers are serious about an overhaul of the tax code — to look at the extent to which all taxpayers benefit from provisions of the tax code. In this update, we look at how taxpayers — based on income — benefit from tax expenditures.

Congress defined tax expenditures as “those revenue losses attributable to provisions of the federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability.” The major tax expenditures fall into four categories: exclusions, itemized deductions, preferential tax rates and tax credits. Exclusions include things like the tax-free status of employer-paid health insurance; deductions include the mortgage interest deduction; preferential tax rates include reduced rates on income from capital gains and dividends, and credits include things like the earned income tax credit (EITC). […]

Lower-income taxpayers benefit more from credits like the child tax credit and the earned income tax credit, while upper-income households benefit more from itemized deductions and preferential tax rates on capital gains and dividends.

One telling way to see this is to look at what would happen to incomes if tax expenditures were erased.  The Tax Policy Center has estimated that eliminating all individual income tax expenditures would reduce the after-tax income of all taxpayers by 12.3 percent. The reduction in after-tax income would range from 7.5 percent for households in the lowest income quintile to a 19.8 percent for those above the 99th income percentile.

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