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The Freeloader Myth
From the Nov. 28, 2011, issue of NR


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Ramesh Ponnuru
The Tax Foundation, a conservative think tank, has estimated how many people paid income taxes each year going back to 1950. That year 28 percent of filers had no (or negative) income-tax liability. It dropped for the next two decades, reaching a trough of 16 percent in 1969. It rose, bumpily, back to 26 percent during the Carter years, fell again to 18 percent in 1984, and then began to rise — especially after the Gingrich Congress introduced the child credit. Pres. George W. Bush expanded that credit, and also reduced the 15 percent tax rate that applied to many lower-income workers to 10 percent. Both moves increased the number of people with no income-tax liability. During the last few years, the number leapt upward because of the severe economic slump. Many people saw their incomes drop to levels at which they were eligible for the earned-income tax credit, for example. It is generally assumed that the percentage of non-payers of income tax will drop once a real recovery begins.

That last point is one that liberals typically make when confronting conservative complaints about the 47 percent: The figure is temporarily inflated. The other thing liberals typically say is that the vast majority of people who do not pay income taxes pay other taxes to the federal government, especially the payroll tax. Federal taxes are still “progressive” — higher earners pay a disproportionate share of federal taxes — but the Tax Policy Center estimates that only about 18 percent of filers pay neither income nor payroll tax.
 
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How to count payroll taxes is a disputed subject. Many conservatives argue that since payroll taxes are dedicated to Medicare and Social Security, people who pay only payroll taxes are contributing to their retirements but not to the general operations of the government. The irony here is that FDR deliberately and explicitly introduced the payroll tax to accompany Social Security because it would encourage people to draw this false connection. In reality, the relationship between payroll taxes sent to Washington and Social Security benefits sent back is loose: Today’s beneficiaries get much more than they sent, and tomorrow’s will get less. (In the case of Medicare, there is no relationship.)
 
The point of the payroll tax, for FDR, was to ensure that “no damn politician” could ever take away the benefits because (to paraphrase conservative author William Voegeli) all the damn voters would think they had earned those benefits through their payroll taxes. All federal taxes go to the federal government, and all federal spending comes from it: The rest is accounting, and accounting tricks. People who pay payroll taxes are funding the federal government, and conservatives who deny it are falling for a trap FDR set for them.
 
It follows that the conservative hostility to “refundable” tax credits is mistaken. If a tax credit counts as a tax cut when it applies against income taxes, it counts as one when it applies against payroll taxes too. A particular credit may or may not represent sound policy, but that determination cannot turn on refundability.
 
It matters how we treat payroll taxes because, while fewer people pay income tax than did so in the Seventies, the burden of the payroll tax has gotten heavier. Count both the payroll and income tax and there is no trend toward lighter federal taxes on the lower-middle class. The Tax Policy Center has estimated tax rates over time for families of four who make half the median income. People at that income level in 1955 paid 2 percent of their income to the federal government and faced a 2 percent marginal tax rate on their next dollar earned. People at that income level in 2005 paid the federal government 4.2 percent of their income and faced a marginal rate of 38.7 percent.


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