Why do half of all Americans pay no federal income taxes?

You’ve probably heard that half of all Americans don’t pay any federal income tax. They pay other taxes, of course: payroll tax and state and local taxes and sales taxes and various government user fees. But they don’t pay federal income tax. Ever wondered why?

A new report (pdf) from the Tax Policy Center breaks it down. In 2011, about 46 percent of households won’t pay income taxes. For about half of them, the standard provisions of the income tax wiped out their liability. If you don’t make any money but you take a standard deduction and have a few dependents, you’re not going to pay any income tax. Roberton Williams, one of the report’s authors, gives the example of “a couple with two children earning less than $26,400. They get an $11,600 standard deduction and four exemptions of $3,700, and that takes their liability to zero. As he says, “the basic structure of the income tax simply exempts subsistence levels of income from tax.”

For the other half, various tax expenditures wipe out their liabilities. Elderly tax benefits are the biggest player here. They get an extra standard deduction, an exemption for some Social Security benefits, and more. Then come various tax credits for children -- for instance, the Child Tax Credit in the Bush tax cuts -- and the working poor. And then come a lot of smaller credits that you can read about in the paper. But the basic story here is that once you've added together the standard features of the tax code and the tax expenditures for the elderly, poor and young, you've explained almost everyone who doesn't pay taxes.

Many politicians complain about the number households that don’t pay income taxes. But they complain about them in very general terms. Sen. John Cornyn, for instance, took to the floor of the Senate to argue that “right now, the fact [is] that according to the Committee on Joint Taxation, 51 percent — that is, a majority of American households — paid no income tax in 2009. Zero. Zip. Nada. … Actually, to show how out of whack things have gotten, 30 percent of American households actually made money from the tax system by way of refundable tax credits — the Earned Income Tax Credit, among others. So 51 percent of American households paid no income tax in 2009, but 30 percent actually made money under the current system.” But he wasn’t very clear on what he would do about it.

Would he repeal the Bush tax cuts? That would bring households benefiting from the expanded Child Tax Credit and the lower marginal rates back into the system. Would he propose that seniors get a smaller standard deduction, or pay taxes on their full Social Security benefit? Would he lower the standard deduction for non-seniors? Would he say that these programs should be conducted through direct spending rather than the tax code, and so the Earned Income Tax Credit will simply send low-income beneficiaries a check rather than first wiping out their tax liability? His statement mentioned tax reform, but it didn’t get into any of these details.

And it’s also worth noting that if you dramatically changed the amount of federal income tax these households pay, their total tax liability as a share of their total income could end up significantly higher than what the rich pay, as state, local and payroll taxes take a big bite out of the paychecks of lower-income households: