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Yvonne Caurion of New York City prepares her U.S. 1040A Individual Income Tax form at a U.S. Post office in New York, April 15, 2010. (MIKE SEGAR/REUTERS)
Yvonne Caurion of New York City prepares her U.S. 1040A Individual Income Tax form at a U.S. Post office in New York, April 15, 2010. (MIKE SEGAR/REUTERS)

Economy Lab

U.S. tax debate through the looking glass Add to ...

In the Alice-in-Wonderland debate about U.S. tax policy, it's just as easy, if not more so, to hear that the real problem is that too many Americans "pay no taxes," while the rich are soaked.

The U.S. tax system is fundamentally flawed, the argument goes, and the most urgent reform is raising income tax rates on the poorest Americans to ease the overwhelming burden on the rich.

Here's an example, taken from a segment last week on the CNBC business-news channel on reforming the tax system. Scott Hodge, president of the right-leaning Tax Foundation, called the system "absolutely broken" because "we're relying too much on those at the top."

"We need to broaden the tax base and bring many of those people who no longer pay any income taxes back on the tax rolls," Mr. Hodge said. "We simply can't rely on a smaller and smaller group of Americans to pay the nation's tax bills. We have to bring the cost down to everyone."

Let's set aside for a moment the issue of how much the rich are paying and look at the argument that too many people are paying "no taxes."

Mr. Hodge, at least, qualified his comment by referring to "income taxes." And the CNBC anchor more accurately said "half the country pays no net federal income taxes after deductions."

Too often, however, the specifics are lost, as in the graphic CNBC ran on the screen saying " HALF OF COUNTRY PAYS NO TAXES AT ALL."

The Tax Policy Center, a joint venture of left-leaning think-tanks the Urban Institute and the Brookings Institute, drilled down a year ago to explain the phenomenon, which it says is primarily because Congress "has chosen to deliver large portions of social policy through the tax code" via deductions and tax credits.

The Tax Policy Center's Roberton Williams estimated in mid-2010 that 45 per cent of households would owe no federal income tax that year, with more than 90 per cent of them getting government payments through refundable tax credits. Six of 10 non-payers have income below $20,000, he said.

More than two-thirds of people who pay no income tax do pay Medicare and Social Security payroll taxes, though, and about half the "non-payers" owed payroll taxes that exceeded their refundable tax credits. "Counting income plus payroll tax liabilities, less than a quarter owe no tax," Mr. Williams wrote.

Tax Policy Center then ran simulations removing all dependent exemptions, itemized deductions and personal credits. Counting both income and payroll taxes, less than 13 per cent of households would not pay tax, with 94 per cent of them either elderly or having incomes less than $20,000.

"Get rid of tax preferences and tax benefits for dependents and it's pretty much just the poor and elderly who don't pay federal income or payroll taxes," Mr. Williams wrote. "And even they likely pay federal excise taxes on gas, alcoholic beverages and other goods."

As for the burden on the rich? That could be a whole other topic. But in 2008, the top 1 per cent of earners had 20 per cent of the adjusted gross income but paid 38 per cent of the taxes, according to IRS data publicized by the Tax Foundation.

It sounds unfair, except that it's been a long-standing hallmark of the progressive tax system.

Let's look at the ratio of share of taxes paid to share of income for the top 1 per cent.

The 2008 figure of 1.9 (that's 38 per cent divided by 20 per cent) is in line with figures from the last two decades; the ratio has ranged from 2.10 in 1993 to 1.77 in 2007.

What has changed markedly, as has been frequently noted, is the share of income the top 1 per cent collects; it was 12.3 per cent in 1987 and 20.0 per cent in 2008. The share topped 20 per cent in each of the four years from 2005 to 2008; it had been over 20 per cent in only one other year since 1987.

It was the Wall Street Journal editorial page which, rather infamously, referred to the households who pay little or no taxes as "lucky duckies." You can be the judge as to who the luckiest Americans are.

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