A great deal of ink has already been spilled over Mitt Romney’s remarks at a fundraiser concerning the 47% of Americans who are dependent on government and who do not pay federal income taxes. A few thoughts immediately come to mind:
Last July, Roberton Williams of the Tax Policy Center broke down why 46% of tax units had no income tax liability, drawing on the findings of a TPC report he co-authored with Rachel Johnson, James Nunns, Jeffrey Rohaly, and Eric Toder. The story is complicated, and it doesn’t line up well with the dependency story Romney seemed to have in mind.
(It is worth noting, incidentally, that “tax units” aren’t a perfect proxy for individuals or even households. Rather, it refers, as you’ve probably guessed, to individuals or to married couples who’ve decided to file a joint tax return, along with their dependents. A multigenerational household might include several tax units, for example.)
Part of the story is that many tax units — roughly half of the 46% — report very low incomes:
For example, a couple with two children earning less than $26,400 will pay no federal income tax this year because their $11,600 standard deduction and four exemptions of $3,700 each reduce their taxable income to zero. The basic structure of the income tax simply exempts subsistence levels of income from tax.
So what about the other half?
What about the rest of the untaxed households, the 23 percent of households who don’t pay income tax because of particular tax breaks? We divided tax expenditures (special provisions in the tax code that benefit particular taxpayers or activities) into eight categories and asked which ones made the most people nontaxable. The conclusion: Three-fourths of those households pay no income tax because of provisions that benefit senior citizens and low-income working families with children. Those provisions include the exclusion of some Social Security benefits from taxable income, the tax credit and extra standard deduction for the elderly, and the child, earned income, and childcare tax credits that primarily help low-income workers with children (see graph). Extending the example offered above, the couple could earn an additional $19,375 without paying income tax because their pre-credit tax liability of $2,056 would be wiped out by a $2,000 child tax credit and $57 of EITC.
Republicans have championed the EITC as an anti-poverty tool that emphasizes the importance of labor force participation, and the program is rightly regarded as a success, though of course there is a case for improving the program in various ways or indeed for shifting to wage subsidies that would also benefit low-wage workers who aren’t custodial parents. The idea behind the EITC, as I understand it, is that subsidies aimed at increasing labor force participation and other work supports are preferable to a negative income tax or unconditional cash assistance because they encourage people get on the first rungs of the jobs ladder, and to become less dependent over time. (See our discussion of the EITC vs. the NIT.)
Tax credits for parents are arguably an extremely low-cost way to recognize the fact that raising the next generation constitutes an expensive investment in human capital that will yield dividends for society as a whole. Tax breaks for Social Security payments, meanwhile, can be defended on the grounds that they are not likely to create significant work disincentives.
Over the years, I’ve advocated wage subsidies because I am very concerned about declining labor force participation, particularly for less-skilled men, and I tend to think that the social benefits outweigh the cost. Along with Ross Douthat, Ramesh Ponnuru, Robert Stein, and Yuval Levin, among others, I’ve also advocated dramatically expanding the child tax credit, and allowing it to offset not just income taxes but payroll taxes as well. More recently, I have embraced Andrew Biggs’ suggestion that we abolish the Social Security payroll tax for workers over the age of 62 on the grounds that it would increase labor supply, improve health outcomes, and increase tax revenues by enough to make the proposal a fiscal wash.
What is the basic idea that ties these threads together? I think it is important to keep in mind that taxes impact people differently across the life cycle. Many low-income households are headed by young people. Many high-income households, in contrast, are headed by prime-age individuals. Some prime-age individuals have children, and they are thus obligated to make substantial human capital investments in their children that generate significant spillover benefits. Other prime-age individuals do not have children. This is, in my view, a difference in circumstances that should be reflected in tax policy. As we’ve discussed in this space, the elasticity of taxable income varies across individuals and broad demographic groups, e.g., very young and workers close to retirement appear to be more tax-sensitive than prime-age workers, and secondary earners are more tax-sensitive than primary earners. None of this should be shocking. Indeed, to some extent the increase in the number of tax units that do not pay federal income taxes is an artifact of the changing demographic composition of the workforce, as well as the expansion of the EITC, etc.
The version of conservative tax policy I favor might actually further reduce the share of tax units that pay federal income taxes, yet it would strengthen the work ethic, increase labor force participation, and discourage the kind of dependency that concerns Mitt Romney.
There is much more to say. The Democratic coalition does indeed include many low-income voters, yet it also includes large numbers of upper-middle-income and high-income voters as well. Public employees tend to back Democratic candidates, and one assumes that most pay federal income taxes. The same is true of most college-educated social liberals. In contrast, many older voters and middle-income parents back Republican candidates. And so on.
One thing that frustrates me is that many Republicans who’ve embraced the “takers” interpretation of the fact that 46% of tax units didn’t pay federal income taxes forget why Republican policymakers of the past created policies like the EITC and the child tax credit in the first place. This lends credence to the analysis of center-left critics like Ezra Klein of Wonkbook:
Part of the reason so many Americans don’t pay federal income taxes is that Republicans have passed a series of very large tax cuts that wiped out the income-tax liability for many Americans. That’s why, when you look at graphs of the percent of Americans who don’t pay income taxes, you see huge jumps after Ronald Reagan’s 1986 tax reform and George W. Bush’s 2001 and 2003 tax cuts. So whenever you hear that half of Americans don’t pay federal income taxes, remember: Ronald Reagan and George W. Bush helped build that. (You also see a jump after the financial crisis begins in 2008, but we can expect that to be mostly temporary.)
Some of those tax cuts for the poor were there to make the tax cuts for the rich more politically palatable. “Do you think we wanted to include a welfare payment to people who don’t pay taxes and call it a tax cut?” A top Bush administration official once asked me. “No. But that’s what we needed to do to get it done.”
Having spoken to other Bush administration officials, I can attest to the fact that there were others who genuinely supported the expanded child tax credit and EITC on the grounds that these were sound conservative policy measures.
Ezra concludes that the narrowing of the tax base is part of a larger effort:
So notice what happened here: Republicans have become outraged over the predictable effect of tax cuts they passed and are using that outrage as the justification for an agenda that further cuts taxes on the rich and pays for it by cutting social services for the non-rich.
A more parsimonious explanation is that cohort replacement and a lack of a sense of history is doing all of the work: many of today’s Republicans are unacquainted with the case for the EITC and the child tax credit and the exclusion of Social Security benefits, or they fail to connect these initiatives to the narrowing of the tax base. This isn’t a sinister plot. But it needs to be addressed. We need conservative politicians who are willing to explain why low-income and middle-income parents should be removed from the tax rolls during the years they are making the biggest investments in their children, and who are willing to make the case for the EITC program as an alternative to worklessness and lifelong dependency.