The Corner

How Tax Day Became Payday

You can’t get something for nothing. At least, that’s how the old saying goes. For almost half of all taxpayers, however, that is no longer true. That’s because they pay no federal income taxes. For them, Tax Day has become just another day on the calendar.

Since the federal income tax is the predominant revenue raiser for the federal government, these “nonpayers” receive government services and benefits without sharing any of the costs. If more taxpayers continue to drop off the tax rolls and become nonpayers, we will soon pass the dangerous tipping point where more than half of taxpayers are nonpayers.

Passing the point at which less than half of all tax filers pay income taxes is dangerous because beyond that threshold, approximately a majority of voters could vote themselves an increasing share of government benefits at no cost to themselves. In fact, when the U.S. passes that point, a shrinking minority of tax filers will be financing almost all government spending. In this situation, politicians have even less incentive to restrain government spending because more votes could be won by increasing spending than lost by increasing the tax burden. That is a deadly recipe for never-ending increases in government spending that will inevitably lead to a fiscal implosion when there are no longer enough productive taxpayers to pay the bill for the expanding welfare state.

Nonpayers are growing rapidly because of the recent explosion in the number tax credits available in the tax code. Both political parties are fond of credits because they can use them to target tax cuts at politically valuable groups and convey benefits on those that engage in behaviors they deem beneficial. Credits for buying hybrid cars or improving the energy efficiency of your home are good examples.

To make matters worse, most non-payers not only pay no income taxes, but actually collect cash payments through the tax code. For these recipients of government redistribution, Tax Day is like an extra payday. They get this cash because of refundable tax credits. Refundable credits can wipe out all of a taxpayer’s income-tax liability and send them cash if there is any remaining value for the credit. In 2010, the three largest refundable credits (the earned income tax credit, the Making Work Pay credit and the child tax credit) will redistribute over $114 billion to the families that claim them.

 

The families receiving cash from refundable credits are growing dependent on the government for an increasing share of their income each year. Growing dependence reduces individual initiative to achieve for those that receive cash payments and at the same time decreases the incentive for top performers to work harder and earn more. These effects will stifle the economy and ultimately lead to a lower standard of living, should these conditions persist. 

Many have grown accustomed to not paying federal income taxes and getting their cash payments, so fixing the problem won’t be easy. But if current trends continue, dependency will threaten the vitality of our economy and government spending will lead us to bankruptcy.

Curtis Dubay is a senior analyst in tax policy in the Thomas A. Roe Institute for Economic Policy Studies at the Heritage Foundation.

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