Fiscal Fact No. 27

One of the biggest obstacles facing President Bush’s Advisory Panel on Federal Tax Reform is the fact that America has become divided between a growing class of people who pay no income taxes and a shrinking class of people who are bearing the lion’s share of the burden.

Despite the charges of critics that the tax cuts enacted in 2001, 2003 and 2004 favored the “rich,” these cuts actually reduced the tax burden of low- and middle-income taxpayers and shifted the tax burden onto wealthier taxpayers. Tax Foundation economists estimate that for tax year 2004, a record 42.5 million Americans who filed a tax return (one-third of the 131 million returns filed last year) had no tax liability after they took advantage of their credits and deductions. Millions more paid next to nothing.

As Figure 1 and Table 1 show, the number of Americans who paid no income taxes because of the preferences in the tax code has varied greatly since 1950. While the number of these “non-payers” has averaged about 22 percent of all filers over the past five decades, it has spiked to record levels in recent years and the trend line does not appear to be slowing.

Table 1. Number of Tax Filers with Zero Tax Liability, 1950-2004 Year Total Tax Returns Filed Tax Returns with Zero Tax Liability Percentage of Tax Returns with Zero Tax Liability 1950 53,060,098 14,873,416 28.0% 1951 55,447,009 12,798,399 23.1% 1952 56,528,817 12,652,544 22.4% 1953 57,838,184 12,615,033 21.8% 1954 56,747,008 14,113,948 24.9% 1955 58,250,188 13,561,123 23.3% 1956 59,197,004 12,938,358 21.9% 1957 59,825,121 12,959,806 21.7% 1958 59,085,182 13,433,048 22.7% 1959 60,271,297 12,774,384 21.2% 1960 61,027,931 12,966,946 21.2% 1961 61,499,420 12,916,655 21.0% 1962 62,712,386 12,620,023 20.1% 1963 63,943,236 12,620,015 19.7% 1964 65,375,601 14,069,263 21.5% 1965 67,596,300 13,895,506 20.6% 1966 70,160,425 13,451,349 19.2% 1967 71,651,909 12,978,971 18.1% 1968 73,728,708 12,440,000 16.9% 1969 75,834,388 12,112,994 16.0% 1970 74,279,831 14,962,460 20.1% 1971 74,576,407 14,660,035 19.7% 1972 77,572,720 16,703,713 21.5% 1973 80,692,587 16,425,425 20.4% 1974 83,340,190 16,005,423 19.2% 1975 82,229,332 20,738,595 25.2% 1976 84,670,389 20,249,022 23.9% 1977 86,634,640 22,253,502 25.7% 1978 89,771,551 21,083,246 23.5% 1979 92,964,302 20,999,319 22.6% 1980 93,902,469 19,996,225 21.3% 1981 95,396,123 18,671,399 19.6% 1982 95,337,432 18,302,132 19.2% 1983 96,321,310 18,304,987 19.0% 1984 99,438,708 17,799,199 17.9% 1985 101,660,287 18,813,867 18.5% 1986 103,045,170 19,077,757 18.5% 1987 106,996,270 20,272,474 18.9% 1988 109,708,280 22,572,948 20.6% 1989 112,135,673 22,957,318 20.5% 1990 113,717,138 23,854,704 21.0% 1991 114,730,123 25,996,536 22.7% 1992 113,604,503 26,872,557 23.7% 1993 114,601,819 28,166,452 24.6% 1994 115,943,131 28,323,685 24.4% 1995 118,218,327 28,965,338 24.5% 1996 120,351,208 29,421,858 24.4% 1997 122,421,991 28,950,791 23.6% 1998 124,770,662 31,722,764 25.4% 1999 127,075,145 32,529,065 25.6% 2000 129,373,500 32,555,897 25.2% 2001 130,255,237 35,491,707 27.2% 2002 130,076,443 39,112,547 30.1% 2003 130,571,319 41,467,439 31.8% 2004* 131,113,969 42,545,501 32.4% * Estimated.

Source: IRS, Tax Foundation Individual Tax Model

In addition to these non-payers, roughly 15 million individuals and families earned some income last year but not enough to be required to file a tax return. When these non-filers are added to the non-payers, they add up to 57.5 million income-earning people who will be paying no income taxes.

Even 57.5 million is not the actual number of people because one tax return often represents several people. When all of the dependents of these income-producing people are counted, roughly 120 million Americans – 40 percent of the U.S. population – are outside of the federal income tax system.

Considering how fast this population of Americans outside of the income tax system is rising, it is important for lawmakers to have a better understanding of who they are. To gain a better insight into the economic and demographic profile of these Americans, Tax Foundation economists employ a sophisticated database that combines IRS tax return data with Census household data.

A Portrait of Non-Payers

Individuals and families who will earn enough to file a tax return can eliminate their tax liability by taking advantage of credits and deductions in the tax code. Many of these are familiar to all tax filers: the personal exemption is worth $3,100 in 2004, and the standard deduction is worth $4,850 for singles and $9,700 for married couples. For tax filers who have itemized deductions that exceed the standard deduction, there are the amounts paid for mortgage interest or given to charity as well as various education-related deductions. Business owners can take advantage of an even wider array of credits and deductions to reduce their tax liability.

In 1997, Congress enacted a new $500 per-child tax credit and expanded the Earned Income Tax Credit (EITC) for low-income workers. The 2003 tax cuts increased the value of the child credit to $1,000. These two tax credits – especially the child credit – have had a powerful effect on reducing, and many cases eliminating, the income tax liability for millions of Americans.

These two credits are unique in that a taxpayer can receive the full value of the credit even if they have no tax liability. To see how this works, consider, for example, a family that has three children (and thus should receive $3,000 in tax credits), but only has a tax liability of $1,505. Under the rules of most tax credits, this family would only be allowed $1,505 in tax relief – an amount equal to their tax liability. But a “refundable” tax credit gives this family the full amount they are eligible for — $1,505 toward their tax liability, and the remaining $1,495 in the form of a refund check. (See Table 2.)

Table 2. How “Refundable” Tax Credits Work Married Couple with Three Children Tax Liability Under 2004 Tax Law Adjusted Gross Income in 2004 $40,000 Minus Standard Deduction -$9,700 Minus Personal Exemption -$15,500 Taxable Income $14,800 Gross Taxes Owed $1,505 Minus 3 Child Credits -$3,000 Taxes Owed $0 “Refundable” Credit Received $1,495

Of the 42.5 million tax returns that pay no income taxes, 52.9 percent received some form of a refundable credit – either the EITC or the child tax credit. In 2004, Uncle Sam paid out about $33 billion in “refundable” checks to the families and single individuals who qualified for the Earned Income Credit and another $9 billion to families who were eligible for the child credit.

Broadly speaking, the 42.5 million zero-tax filers are: low-income, young, female-headed households, part-time workers, and beneficiaries of the $1,000 per-child tax credit or the Earned Income Credit. (See Table 3.)

Table 3: Demographic Profile of Zero-Tax Filers and Non-Filers Distribution of 42.5 Million Non-Paying Filers Distribution of 15 Million Non-Filers Distribution of Combined 57.5 Million Zero-Tax Population Income $1–$19,999 90.8% 98.9% 92.9% $20,001–$39,999 5.2% 0.6% 4.0% $40,000–$74,999 3.7% 0.5% 2.9% $75,000+ 0.24% 0.02% 0.2% Age <18–24 34.9% 9.9% 28.4% 25–34 18.6% 7.7% 15.8% 35–44 20.7% 9.7% 17.8% 45–54 10.8% 10.0% 10.6% 55+ 15.0% 62.8% 27.5% Race or Ethnicity White 79.4% 75.2% 78.3% African American 16.3% 20.1% 17.3% American Indian 1.2% 1.3% 1.2% Asian America 3.2% 3.4% 3.2% [Hispanic American] [14.0%] [11.5%] [13.5%] Gender of Major Earner Male 46.0% 37.4% 43.8% Female 54.0% 62.6% 56.2% Filing Status* Single 44.4% 32.1% 41.2% Married Filing Jointly 27.7% 55.5% 34.9% Married Filing Separately 1.3% 4.7% 2.2% Head of Household 26.5% 7.8% 21.6% Widow(er) 0.1% 0.0% 0.1% Working Status Full-Time 50-52 Weeks 34.6% 1.5% 25.9% Full-Time Less than 50 Weeks 19.9% 1.7% 16.0% Part-Time More than 13 Weeks 26.6% 3.6% 20.9% Part-Time Less than 13 Weeks 18.9% 95.3% 38.8% * Filing status of non-filers assigned using Census definitions, not strictly comparable to IRS definitions used for all filers.

Source: Tax Foundation

Income

The 42.5 million non-payers are largely low-income. Indeed, 91 percent of them earned less than $30,000 per year and 96 percent earned less than $40,000. Fewer than 1 percent will earn more than $75,000 per year – a group comprised largely of business owners whose tax liabilities will be erased due to business losses, carry-overs from prior year AMT payments, or foreign tax credits.

Age

Non-payers in 2004 were overwhelmingly young. Looking at the age of the primary breadwinner on these tax returns, only 26 percent are 45 years old or older. More than one-third (35 percent) are younger than age 25, and 54 percent are younger than age 35. Interestingly, there is a significant cluster of households (20.7 percent) where the principal wage earner is between the ages of 35 and 44. Most likely, these are modest-income families who benefited most from the doubling of the value of the child credit to $1,000 and were, thus, pushed into the non-payer status.

Race or Ethnicity

The racial or ethnic composition of the 42.5 million non-payers roughly mirrors the demographics of American tax filers as a whole. For example, white Americans are 83 percent of total taxpayers, and the percentage of zero-tax filers who are white is 79 percent. African Americans are roughly 13 percent of total taxpayers and 16 percent of zero-tax filers. Asian Americans comprise 3.6 percent of total taxpayers and 3.2 percent of zero-tax filers.

That said, the percentage of non-payers within each ethnic or racial group does vary: 28.6 percent of Asian Americans tax filers get back every dollar withheld, 31.1 percent of white American tax filers will owe nothing, and 41.7 percent of African Americans will file a tax return with no liability.

Absent from these categories are Hispanic Americans. Within Census data, race and ethnic Hispanic origin are not comparable concepts because a Hispanic individual can be of any race. As a result, Hispanics Americans must be considered separately from racial characteristics. Hispanics make up 15 percent of the 42.5 million individuals or households that paid no income taxes in 2004. In contrast, they made up roughly 10 percent of all 131 million taxable American households.

Gender

Some 54 percent of non-payers are single women or families with children where the principal wage earner is a woman. That leaves 46 percent of non-payers in 2004 who are either men or families in which a man is the major breadwinner.

Filing Status

The overwhelming majority of tax returns that owe no income taxes are filed by single individuals or heads of household (an unmarried individual with children). Due in large part to their young age, 44.4 percent of these filers are single persons without children, while 26.5 percent are single parents. By contrast, heads of household comprise just 14 percent of all tax returns. Married couples comprise just 27.7 percent of tax returns with no income tax liability.

Work Status

Non-payers tend to be low-income, working part-time or full-time for only part of the work year. Indeed, 45.5 percent will be working part-time or hardly at all, while another 20 percent are working full time but less than 50 weeks out of the year. Indeed, 7.5 million of these individuals who file a tax return earn less than the threshold amount for filing a tax return, but do so just to recover the amount of taxes that were withheld during the course of their part-time employment. Just 34.6 percent of zero-tax filers worked full-time for all of 2004.

Occupation

The occupations of non-paying tax filers are difficult to generalize because of the large number of categories government statistics tend to group them in. However, due again to their young age, 24 percent of these filers are classified as “children” or “students” rather than their occupations. The other leading occupational categories are “other services” (16.6 percent), “administrative support” (11.2 percent), “sales” (11.0 percent), and “precision production” (7 percent).

Who Doesn’t Have to File?

Americans are required to file a tax return if their income is over a certain amount. For single individuals under 65, that amount was $7,950 in 2004. For those 65 or older, the amount was $9,150 (Social Security benefits are not included). Married couples must file if their gross income is at least $15,900 ($17,800 for couples over age 65). Heads of households (single parents) must file if they earn at least $10,250.

Broadly, people who did not earn enough to file a tax return for 2004 (“non-filers”) are college students, retirees, and single parents. They have part-time jobs but earn less than the minimum amounts that are required to file a tax return.

Income

Of the 15 million income-earning households that do not file a tax return, some 98.9 percent earn less than $30,000, while roughly 99.5 percent earn less than $40,000.

Age

While non-paying Americans tend to be young, two-thirds (or 9.4 million) of the non-filers are older than age 55. By contrast, only 15 percent of the larger population of non-payers are older than age 55. As Table 3 shows, when non-payers and non-filers are combined, more than half of all households that pay no income taxes are either younger than age 25 or older than age 55.

Race and Ethnicity

Among the 15 million in the non-filing population, the ethnic differences are slightly more pronounced than the population as a whole. For example, 75 percent of the non-filing households are White Americans while 20 percent are African Americans and 3 percent are Asian Americans.

When we combine the populations of non-payers and non-filers and look to see what overall percentage of each group is not paying taxes, we find that: 50.7 percent of African American households pay no income taxes, 35.5 percent of Asian American households do not, 37.6 percent of White American households do not, and roughly 52 percent of Hispanics pay no income taxes.

Gender

Among the population of non-filers, female-headed households are even more dominant. Roughly two-thirds of these households are headed by women, whereas 37 percent are headed by men.

Work Status

Not surprisingly, 93 percent of non-filing households are considered non-workers – meaning they worked less than 13 weeks out of the year. Only 1.46 percent of non-filers will have worked full-time during 2004.

Conclusion

In 2004, a record 42.5 million tax returns – one-third of all returns filed – had no income tax liability because of the available credits and deductions in the tax code. This is a 42 percent increase in the number of zero-tax filers in just four years. In addition to these zero-tax filers are the 15 million individuals or households who do not earn enough to file a tax return. Overall, nearly 58 million taxable households are outside of the income tax system.

These findings raise serious questions about the future of the U.S. income tax system. Are any future tax cuts, or even tax reforms, possible when the lion’s share of the tax burden is increasingly borne by a shrinking pool of taxpayers who – at least on paper – appear to be “upper-income”? And will the expanding pool of non-payers demand even higher income taxes? These are questions lawmakers must begin to debate.

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