Federal Income Tax Disparity

The result of out of control government spending coupled with diminishing numbers of federal income tax payers.

In a report released on July 30, 2009, The Tax Foundation detailed the Federal Individual Income Tax Data. In the report are several interesting statistics, but when coupled with an article written by The Tax Foundation's Scott A. Hodge, those same statistics become quite alarming. Amongst the data contained in the reports is the revelation that the disparity between households which pay federal income tax and those that do not is growing, unsustainably.

First let's break down the remarkable federal income tax numbers. During the period from 1987 to 2007 (the most recent federal income tax data available), the percentage of total tax dollars paid in by the top 1% of earners shot up more than 62% from 24.81% to 40.42%. The percentage paid by the top 10% of wage earners during the same period has increased from 55.61% to 71.22%. Meanwhile, the federal income tax percentage paid by the top 26% to 50% of wage earners (those making between $32,879 and $66,532) has fallen from 17.02% to 10.52%.

Percentage Paid by Group

What these numbers tell us is that the top 10% of wage earners in the United States have had their total federal income tax burden increase by nearly 30% while the top 26% - 50% of wage earners have seen their tax burden decrease by nearly 40%. All the numbers get confusing, so let's graph it out.  In the graph below, 100% represents the tax figure paid in 1987.  The graph plots out how each group of tax payers share has increased or decreased on a percentage basis from 1987 to 2007.

Percentage Increase/Decrease by Group

Now let's take a look at the increasing number of those who do not pay income tax. In his article, "Once Self-Reliant, Now A Nation Of Takers," Hodge points out the record numbers of those receiving a tax refund from the IRS:

We've all seen someone who brings a small salad to the potluck but piles lots of your casserole on his plate. Or, there is always one person in the lunch group who orders the most expensive meal on the menu because she knows you are all splitting the check.

The same thing happens with government. A growing number of Americans are contributing little but taking a lot, and a shrinking number are giving a lot but taking little.

Recent IRS data for 2008 reports that a record 52 million Americans—or 36% of all filers—filed a tax return but had no income tax liability because of the generosity of the credits and deductions that have been enacted over the past 15 years.

The tax code has always had exemptions to protect the poorest Americans from paying income taxes, but the new credits—such as the child tax credit, Making Work Pay credit, and First Time Homebuyer credit—are now exempting middle-class families from the income tax.

Remarkably, a family of four earning up to $52,000 can expect to pay no income taxes because of these various tax credits. That too is a record.

Many more of these taxpayers are now getting checks back from the IRS even though they pay no income taxes. The IRS paid out $70 billion in "refundable" checks to non-payers in 2008. In essence, lawmakers have turned the IRS into an ATM machine for welfare benefits—and ATM now stands for Another Taxpayer's Money.

Sadly, millions of people now see April 15 as payday, not tax day.

Indeed the top 26%-50% of federal income tax payers (those who earn between $32,879 and $66,532) pay a mere 10.52% of the total federal income tax revenue. Theoretically, this group is also the second most likely to utilize support from federal entitlement programs. Sadly, the direction in Washington does not appear to be headed toward righting the problem before us. Hodge continues:

President Obama's policies, from health care to taxes, are all intended to increase the number of takers in America while reducing the number of givers. Our analysis of Obama's FY 2011 budget plan shows that it would increase the amount of redistribution from the top 10% of families by nearly $100 billion per year—to a total of $854 billion—while expanding the amount of government benefits targeted to the middle and upper-middle classes.

Economists have identified a phenomenon they call "fiscal illusion." When people perceive the cost of government is less than what it really is, they will demand ever more government. The real danger today is not just that we have so many non-payers, but that the $1.5 trillion deficit is making the cost of government look cheap for all of us. So much spending is raining down on us that it now seems like "free money" in a sense.

Every marketing guru will tell you that people love free stuff and that they will take as much as they can get whether they need it or not. But for a nation, this is a recipe for fiscal disaster.

This constitutes one of the most major of flaws inherent in the 'progressive income tax.' A progressive tax system is, by definition, not fair. Groups within the tax system are penalized by the fact that they are a member of a specified group. This creates the incentive to 'game' or cheat the system. Looking at our current tax system, if you are in the top 1% of wage earners, and you can find a way to represent your earnings as being within the top 2-5% of wage earners, you can take 22% off the amount you would have paid. At an income of $410,096 that means more than $20,000 in tax money that would otherwise be paid into the federal tax system which is instead in your pocket. Think there's an incentive to cheat?

The increasing discrepancy between the numbers who pay federal income tax those who do not is one of the strongest arguments for a fair tax. The most popular of these would be levied in the form of a national sales tax. Every transaction, taxed at the federally required 23%. A recent article at National Review Online by Ramesh Ponnuru entitled, "A Misleading Sales Pitch" argued that the proposed 23% tax would not be enough:

It is not at all clear that this [23] percent sales tax would raise enough revenue to eliminate income and payroll taxes. Brookings Institution economist William Gale has estimated that to replace current federal tax revenues, the tax rate would have to be 44 percent...

The piece is not so much a damaging blow against the advocacy for a fair tax, as it is an indictment of the cost of entitlement programs. Americans for Fair Tax Reform has a point by point rebuttal of Mr. Ponnuru's more serious charges.

A fair tax coupled with true entitlement reform would correct the imbalance in federal income tax payers and serve to reduce bloat in federal government at the same time. True tax reform is desperately needed, and unless someone appears on the political scene who can put aside personal ambition in favor of reforming our current system, our economic future is sealed and the greatest human experiment is destined for the trash heap.

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