There is Nothing New about Families Paying No Income Tax

By :: August 10th, 2010

Following the flap over our Tax Policy Center colleague Bob Williams’s calculation that close to half of all families did not pay income tax in 2009, we thought it would be instructive to take a look at history. It turns out that over the past five decades, there have been other periods when families with close to average incomes have been exempt from the income tax, and that their current exemption levels were due to both Republican and Democratic efforts to reduce taxes for moderate-income households and to find alternatives to welfare.

Consider the tax entry threshold—the maximum  amount of income that that a family can have without being subject to income tax—and then compare that to median family income. A value of 100% would mean that the threshold is exactly equal to median family income—families earning at or below that level would pay no income tax.

In 1947, a family of four owed income tax once their earnings hit 89 percent of median family income (see table). Over the following three decades, this tax threshold fell steadily, reaching a low point of 33 percent by 1974, just before Congress enacted the Earned Income Tax Credit (EITC). It rose steadily from 1985 to 2003, when it reached 70 percent, where it remained through 2008. While that’s higher than most of the past thirty years, it is still below the levels of the late 1940s and early 1950s.

This u-shaped pattern is somewhat more pronounced for single parents with children, or heads of household (see graph). They began to pay taxes at over 80 percent of median income in the late 1940s, but the threshold fell to a low of 35 percent in 1978 and then rose to over 110 percent in 2008.  For singles, however, the tax entry threshold has actually fallen over time relative to median income: 44 percent in 1947, 38 percent in 1974, and 34 percent in 2008.

Two factors drive these numbers for families with children: (1) the significant decline in the value of the dependent exemption relative to the average family’s income (the 1986 Tax Reform Act was the major exception); and (2) the introduction of and several increases in the EITC and in the Child Tax Credit, which are treated as tax reductions for those otherwise owing tax.

If we exclude the Earned Income Credit and Child Credit and treat them like direct expenditures, the tax threshold as a percent of median income has remained relatively low in recent decades for families with children as well, increasing only slightly even from the relatively low 1975 level. (We did not include temporary effects from the 2008 Economic Stimulus Act. Including them would further increase the threshold at which families would owe tax.)

We need to be careful about interpreting these shifts as a result of liberal or conservative policies. Presidents Gerald Ford, Ronald Reagan, George H.W. Bush, Bill Clinton, and George W. Bush all approved increases in either the EITC or the Child Credit or both—as alternatives to welfare and minimum wage increases, as offsets to Social Security tax increases, and, more generally, as pro-family tax policies. After seeing some of my (Steuerle’s) work on how the decline of the personal exemption over several decades had significantly raised taxes on families with children, Reagan promoted doubling the personal exemption and, later in tax reform, removing poor families from the income tax rolls entirely. Finally, these calculations ignore the rise in the combined Social Security and Medicare tax rate on earnings from 3.0 percent in 1950 to 15.3 percent today. That change, of course, increased federal tax liabilities for low-income working families.

5Comments

  1. Anonymous  ::  4:52 pm on August 10th, 2010:

    That last piece, including FICA, is required if you include an analysis of the EITC, which is essentially a FICA offset for the poorest.
    This analysis also leaves out the cost of being poor, particularly at tax time. The tax benefits are partially offset by preparation costs, which are compounded by interest costs for tax anticipation loans. While smart taxpayers wait and smarter taxpayers do their own taxes or buy tax software, the poor often cannot afford to wait and do not have the educational background to do a tax form. These costs of poverty should also be an offset, as they can be calculated for average households in various circumstances.
    Including all of this helps prove the case for tax simplification – either the automatic filing of 15% rate payers that Len Burman proposes or the more ambitious elimination of low rate income taxes altogether that Michael Graetz proposes – or the even more audacious elimination of both income, disability, non-retiree survivors and hospital insurance taxes that I propose (with VAT and expanded business income tax replacement). As you know, I also propose combining health levies and exclusions into a single tax (the business income tax) while combining all tax benefits for families (exemption, CTC, EITC) into a single tax credit that businesses deliver to employees as part of wages or training stipends (for TANF recipients) at substantially higher levels. I fund this by eliminating home ownership tax benefits.
    I would appreciate it if you scored my plan.

  2. Anonymous  ::  2:54 pm on August 12th, 2010:

    I think there's a basic fallacy in equating tax filing units with families. Let's say my son earns $1000 in a summer job, my dad lives with me and earns only social security, and my wife and I earn a decent income. There's three tax filing units in the family, of which 2/3 will pay no federal income tax – but 100% of this family/household is paying federal income taxes.

  3. Anonymous  ::  7:46 pm on August 13th, 2010:

    Irregardless, if your son with the summer job gets his support from you, you should get the child tax credit for him – he would not get it.

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