One of the most commonly cited statistics about our tax system is that about 50 percent of American tax filers actually pay no federal income taxes. Is that fair?
The explanation is simple: the income tax serves two masters. On one hand, it raises nearly half of all federal revenues. On the other, it delivers a broad array of social benefits in the form of exemptions, deductions, and credits that reward people for government-favored behavior. If we look only at raising revenue, about three-fourths of people pay taxes. It's that social welfare function that knocks so many people off the tax rolls.
Over the past two decades, Congress has repeatedly used the income tax to encourage or subsidize specific activities. We subsidize kids with the child credit, college attendance with multiple higher education credits, retirement with all sorts of tax-favored savings plans, work with the earned income credit, and child care with, you guessed it, the childcare credit. And we've retained most itemized deductions that subsidize homeownership, state and local governments, and charitable giving.
Those subsidies and incentives came out to $950 billion of tax "expenditures" in 2007. It's an enormous figure.
But as Williams explained to me, this particular talking point is a political creation. Electeds, especially moderate and conservative pols, are reluctant to announce spending programs because it makes them look like Big Government Bogeymen. So they execute spending programs through the tax system (because hey, "it's not welfare spending, it's a child tax credit!"). As regular as the tide, tax policy hawks intermittently fret that up to 50 percent of taxpayers pay no net federal income taxes and that this is lamentable. But surely we can see that the reason they're paying no taxes is that our aversion to new spending programs has forced all sorts of actual spending programs to go through the tax system.
This infamous 40-50 percent still pays taxes: local, state, payroll and so on. But I'm sympathetic to the argument that we have a civic imbalance where up to 50 percent of the electorate is voting on federal that they won't actually pay for, since local and state taxes stay local and in-state and payroll taxes go to specific programs like Social Security and Medicare. If tax reformers want to correct this imbalance, I think a broad-based consumption tax or VAT would be a reasonable solution, not to mention a generally smart way to raise federal revenue.