The 47% Myth: Just Who Pays Income Tax, Anyway?

First posted at The Smirking Chimp, April 26, 2010.

"47% of all US households pay no income tax". That's the current buzz in the conservative/libertarian/teabag blogosphere right now. Or maybe it's 47% of workers, or 47% of the population, or...well, a lot of people don't pay any income tax. Various versions of this are flying around, all based on a report last month by the Tax Foundation.
I am told by a libertarian friend of mine, that the Tax Foundation is a non-partisan think tank funded by the "liberal-leaning" Brookings Institute. I suppose that Brookings is "liberal leaning" by the same standard that Ron Paul is, perhaps.

What they really said was that, in 2008, a record number of tax returns were filed that had no income tax liability, about 36.3%. They used preliminary numbers from the IRS, since 2007 is the latest year that we have final numbers for.

So, with all the hubbub out there about all of these tax deadbeats (never mind that almost all of these people pay payroll tax, which Congress has been using as general revenue since the 1930's), I decided to take a peek behind the numbers.

I noticed that the current version of the report deleted the "47% of households" language, given that they were playing pretty fast and loose with both the numbers, as well as the definition of "household". That's good, because it's just not true.

Another untruth in the report is that a family of four making over $50,000/yr pays no income tax, after standard deduction and credits. Nope, sorry. They may not have had much income tax liability, but they had some. I've mocked up a few sample returns to illustrate my points.

I used 2009 instead of 2008 for all of my sample returns, since the breaks just keep getting bigger, mostly thanks to EGTRRA (the 2001 budget busting Bush tax law). Also, last year's stimulus bill had a little goodie in it called the Making Work Pay credit, which was $400 for single filers and $800 for married filers under certain income limitations.

But first, let's get back to how many people aren't paying. In 2008, according to the preliminary numbers, 142 million Federal income tax returns were filed, 51 million of which had no income tax liability on them. That's about 36%. Lotsa deadbeats, huh?
But of the 91 million returns filed that did have tax liability, 63 million or so were married filing jointly. So those 91 million tax returns actually represent 174 million people, and doesn't include the children of those people, for the most part. That's about 53% of the population, which is where the infamous 47% number came from.

So, who are these 150 million or so people who pay no income tax? Well, at least 60 million of them are children under 15. Goddamm deadbeat children! They should be paying their fair share! Close to another 40 million are over 65. While many people over 65 have enough income to have income tax liability, they are a minority. At least 25 million of these people are living on Social Security and not much else. Hence, no tax liability.
So, that leaves about 65 million working age adults who are paying no income tax. About 20% of the overall population. Lucky them. Most aren't making enough money to have to pay, period. Some are disabled, some are students...there are many reasons why. but most are just poor and poorly paid.

But not all of them. And not all of them are who you would expect. The following examples use round numbers, but the situations are based on actual returns that I have prepared. Anyone interested can e-mail me, and I'll gladly send them the pdf files of the example returns.

Let's start with Mr and Mrs Example, who put the lie to the Tax Foundation's $50,000 assertion:

The Examples have 2 preteen children. They're renters, so they don't itemize their deductions. Between them they make $52000/yr at a couple of crappy jobs. Wage income only, since people like this don't usually get to save or invest much money.
For 2009, their tax liability after standard deduction, dependency exemptions, and credits (including the one-time 2009 Making Work Pay" credit) was $269, and would have been $1069 without the MWP credit.

They also had a $1201 tax liability to Colorado.

Mr Example has a brother named Joe. Joe Example works full time for minimum wage at a convenience store. His income for 2009 was $15080.

After the $400 credit, Joe still has $173 Federal income tax liability. He also has a $266 liability to Colorado.

So, maybe they're not paying a fortune, but they're still paying income tax, contrary to the Tax Foundation's assertion.

So, who isn't paying? Here are a couple of fictional examples based on real people.
Bob DevDis is one of the developmentally disabled folks that I do pro bono work for. He works about 30/hr/wk for $7.50/hr. He makes pretzels for one of the airport concessions. He's proud of his pretzels, too.

Bob also gets SSDI. In 2009, his SSDI income came to about $10800. He made about $11250 in wages. For 2009, his $191 income tax liability was wiped out by the $400 MWP credit, and $166 EIC. For 2008, though, he would have had a tax liability of $103 after his EIC.

He did have an $86 liability to Colorado, though.

How about the Example family, though? What if they had one more child? Then they would be a family of five, not four, as in the Tax Foundation assertion. But they wouldn't have any income tax liability, either
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But there is another type of non-payer, a type that used to actually exist in much greater numbers, prior to the Tax Reform Act of 1986. The non-paying millionaire.
Let's take Mary REInvestor (the RE being for Real Estate). She does have a job in marketing, and actually makes as much as the Example family--$52,000 in wage income. But she has some inherited money stashed away, and also has $1700 in interest income, $2500 in non-taxable interest, and $2200 in qualified dividend income.

But her investment income doesn't really indicate her real net worth. She actually owns $5 million of real estate, most of it rental properties. She has about $2 million in leverage against these properties, so her real net worth is actually over $3 million.
But how is she paying the interest on $2 million in loans on only $52000 a year? Well, like I said, she has a decent amount of savings, and she has access to money through the real estate. She collects rents, which don't nearly cover the interest, but it's part of how she manages this. She also refinances her properties frequently, and pulls cash out of each transaction.

Some years, she sells or exchanges properties, and uses the cash to live on, pay the mortgages, etc. Sometimes, she dips into her savings and other investments.
In both 2008 and 2009, she paid no income tax. In 2009, she even got $400 from the MWP credit. How does she do it?

Well, after the wages and investment income, she takes the maximum allowed $25000/yr in rental losses. No big trick, since rental properties almost always lose money anyway. But even though the cash flow is negative, she's still gaining equity in the properties, and her net worth continues to climb.

Then she put $5000 into an IRA. Now her AGI (adjusted gross income) is $25900. She has $27740 in itemized deductions, mostly the $23,250 of mortgage interest on the house she actually lives in. Ta-dah! No taxable income. So she doesn't owe anything to Colorado, either.

This would have worked for her in 2008 or 2009 (in fact, it did), but in 2009, she got to do even better. One of EGTRRA's last gasps was the 2009 super duper tax break on long-term capital gains. 10% for filers above the 15% tax bracket, 0% for those at or below 15%.
So, Mary took advantage of this (possibly) once in a lifetime opportunity. she sold one of her properties at a $19000 profit, which brought her taxable income to $13510. The Federal income tax on this was $0, since the entire $13510 was deemed to be from the capital gain, according to the formula set down in the code, and only put her in the 10% bracket.

Of course, since Colorado has no special rates for investment income, she did end up paying Colorado $706.

So, what about these 65 million working age adults who pay no income tax?
First off, they add up to about 20% of the population, not 47%. They probably don't account for 47% of households, either. They definitely don't add up to 47% of working age Americans. Second, most of them are still paying payroll tax, state income tax, property tax, sales tax, excise taxes...

Also, at least 10 million of them (but probably more) are unemployed.
Of course, as I demonstrated above, at least a few of them are high net worth individuals who are good at playing the system.

So, you can tell all that to your libertarian leaning, conservative or outright teabagging friends, relatives, and coworkers. Even if the Tax Foundation and Brookings Institute are, by some weird measure, "liberal leaning", they're definitely not telling the whole story, and twisting the numbers to get to their own predetermined conclusion.

Don't forget--if you have a hard time believing my examples, or want to throw something in that you think I left out, e-mail me at jmadison.files@gmail.com

I'll be happy to share pdf's of the example tax returns, and, time allowing, may even alter them to reflect more or different information.

Here are the sources:

IRS Preliminary Individual Income Tax Abstract, Tax Year 2008 (This is the IRS report that the Tax Foundation used)

US Census 2008 Estimates