The big tax debate last year was over the rich. In Congress, Republicans and Democrats sparred over extending tax cuts for the wealthiest of Americans. From city to city, Occupy Wall Street protests highlighted the country’s growing income inequality, entering the phrase “We are the 99 percent” into the lexicon to refer to taxpayers outside the top 1 percent income bracket.
Now an important debate is brewing at the other end of the spectrum—over taxing lower-income earners—sparked by an estimate last year by the Joint Committee on Taxation that 51 percent of U.S. households pay no federal income taxes.
Conservatives say the statistic shows that the government has gone too far in sparing low-income Americans from meeting the responsibilities of citizenship. “I don’t want the truly poor to pay anything, but you can’t tell me that 51 percent of all Americans are the truly poor,” says Sen. Orrin Hatch, R-Utah, ranking member on the Senate Finance Committee. “Everyone needs to have some skin in the game and recognize that they are part of the government.”
During one Republican presidential debate, Rep. Michele Bachmann of Minnesota proposed that people on the lowest income rung who receive tax refunds pay $10 in income taxes so that they feel some sense of ownership over the government. Herman Cain tapped into this zeitgeist with his 9-9-9 plan, a flashy, simple-sounding proposal that would have raised taxes disproportionately on lower- and middle-income workers. Even though Bachmann and Cain are no longer in the race, the debate over taxes is far from over.
The conservative line of thinking on federal income taxes goes like this: A greater share of the population should pay a tax bill (even a small one) so that everyone understands the true price of government. The Internal Revenue Service has turned into too much of a welfare agency, rife with abuse. The overly complicated tax system, conservatives say, has inadvertently and almost accidentally created a huge, swelling class of people who, thanks to the refundable Earned Income Tax Credit, completely escape paying federal income taxes. Never mind that the first big expansion of the credit came under President Reagan, whose penchant for trickle-down economics still pervades much of Republicans’ rhetoric surrounding taxes and spending.
“Right now, only the rich are paying taxes,” says Scott Hodge, president of the conservative Tax Foundation. “We’ve created a tax system that simply cannot function and that no longer incentivizes behavior, because there is so little income.”
“The concern is that people who are not paying any federal income taxes creates an entitlement mentality.” —Peter Wehner, former director, White House Office of Strategic Initiatives
In an editorial in August, The New York Times dubbed this GOP stance “the new resentment of the poor.” The newspaper’s editorial board wrote, “These Republican leaders, who think nothing of widening tax loopholes for corporations and multimillion-dollar estates, are offended by the idea that people making less than $40,000 might benefit from the progressive tax code.”
Republicans, not surprisingly, say The Times missed the mark. “I don’t take it as a resentment of the poor as much as resentment toward the tax system,” says Peter Wehner, a former director of the White House Office of Strategic Initiatives under President George W. Bush who also worked in the Reagan and George H.W. Bush administrations. “It’s more directed at the tax code than the people receiving the benefits. It’s an inequality, in their minds, a response to Occupy Wall Street,” Wehner says. “This is a reflexive response among some conservatives, who feel like this is a demonstration of a tax system that, in their minds, is too progressive.”
BEHIND THE 51 PERCENT
The Earned Income Tax Credit is a big reason why 51 percent of households pay no federal income tax. One of roughly 200 tax expenditures on the books, the EITC allows working families making under $49,000 (with three children) or $41,000 (with one child) to receive a refundable tax credit. The size of the credit depends on marital status and family size. Working couples also qualify if their combined income is below $18,700. The credit often refunds more money than people pay, thereby kicking some off the federal income-tax rolls.
In 2009 alone, about 27 million families and individuals claimed the credit. Liberals praise the EITC for encouraging work over welfare and for lifting millions of families with children out of poverty. In his testimony before the Senate Finance Committee in May, economist Aviva Aron-Dine argued that expansions of the EITC in the 1980s and 1990s increased the number of single mothers participating in the workforce by more than 7 percentage points.
Over the past 25 years, the credit has changed the portrait of a person who doesn’t pay any federal income taxes—and in some surprising ways. Before the 1986 tax-reform bill, poor people paid about 0.2 percent of individual income taxes, while the top 1 percent of taxpayers paid about 24.6 percent. By 2007, according to an analysis by the nonpartisan Tax Policy Center, those numbers had shifted. The individual income-tax rates on the poorest filers had turned into a refund of roughly 0.3 percent, and the top 1 percent of taxpayers bore 39.5 percent of the burden.
The cost of the EITC has ballooned along with the number of people taking advantage of it. In 1975, when President Nixon successfully pushed for an enacted the expanded Earned Income Tax Credit, the break cost the government $1.25 million a year. That year 6,215 families received an average credit of $200, according to records from the House Ways and Means Committee.
By 2009, the most recent year for which data are available, about 27 million families and individuals claimed the credit, at a cost of $52.8 billion per year. Families with children collected, on average, about $2,770, while families without children got about $259. The overpayment error rate of the credit also ballooned to more than 23 percent, based on IRS data from 2001 to ’06.
The Tax Policy Center, a think tank affiliated with the Urban Institute and the Brookings Institution, estimates that the number of households that will pay no federal income tax for 2011 will drop to 46.4 percent: Economists say the dip results from unemployed people returning to work and earning wages high enough that they no longer qualify for the credit. As many liberals are quick to point out, however, about 60 percent of households that owed no income tax in 2011 paid payroll taxes. Just 18 percent of households paid neither payroll taxes nor federal income taxes. Most of them were elderly couples or individuals making less than $20,000.
That’s a much smaller, demonstrably poorer, sliver of the 51 percent. It’s also a demographic that is unlikely to generate much revenue.
Reducing the Earned Income Tax Credit, rather than contributing to Republicans’ goal of shrinking the federal government, could have the opposite effect. It could force more people, especially working families, to lean on other government programs such as food stamps for assistance. “It does raise the corresponding dilemma: Is it better to increase taxes, or better to hand out benefits?” says Eugene Steuerle, a fellow at the Urban Institute and a former deputy assistant secretary of the Treasury for tax analysis. “The economics may not come out the same way as the politics.”
Even though the GOP is leading the political war on people who pay no federal income tax, the Earned Income Tax Credit started out as a Republican idea. Congress passed it in 1975 as a way to offset payroll taxes for low-income families with children: a variation of Nixon’s proposal of a negative income tax.
During the 1986 tax-reform debate, Reagan substantially expanded the credit as a way to provide assistance through the tax code by refunding a portion of a person’s tax bill and, in many cases, giving back more money than he or she owed. The expansion was part of broader reform legislation that raised taxes on some corporations while reducing the tax bills of millions of Americans.
“It was a pretty good speech line,” remembers Ken Kies, chief Republican tax counsel at the House Ways and Means Committee in 1986. “Reagan did believe in lower taxes in general, but he also had a soft spot for people who weren’t doing so well.”
That was certainly the message that Reagan shared with the country at the bill signing in late October 1986. From the White House’s South Lawn, he declared: “This tax bill is less a freedom—or a reform, I should say—than a revolution. Millions of working poor will be dropped from the tax rolls altogether. And that’s why I’m certain that the bill I’m signing today is not only an historic overhaul of our tax code and a sweeping victory for fairness; it’s also the best antipoverty bill, the best pro-family measure, and the best job-creation program ever to come out of the Congress of the United States.”
Over the next 20 years, congressional Republicans and Democrats, in bipartisan collaboration, expanded the Earned Income Tax Credit. In 1987, the government indexed the credit for inflation. In 1990, lawmakers expanded it to make sure that low-income families were not hit by deficit-reduction measure; and in 1993, they broadened it to include childless workers. Combined, these last two changes almost tripled the program’s price tag, according to a Brookings study. Some states also began offering their own versions of the EITC.
To combat fraud, Washington also tweaked the mechanism for collecting the credit. To qualify, taxpayers needed to have a Social Security number for themselves and any dependents, and anyone who claimed the credit under false pretenses risked the loss of his or her eligibility for 10 years.
Because of the expansion of the Earned Income Tax Credit over time, many people who pay no federal income taxes aren’t the poorest of the poor, as Hatch says. Instead, they’re working families and single parents who have benefited from Republican- and Democrat-endorsed tax policies that rewarded work and family—hardly a group that’s easy to write off as welfare loafs.
ZERO, NADA, ZIP
The Urban Institute’s Steuerle remembers the media buzz when the Tax Policy Center released its estimate in 2009 that roughly 47 percent of Americans paid no federal income taxes. “We still worry about whether that number is interpreted correctly,” he says.
Conservatives and journalists seized on the statistic, so much so that the center published several follow-up blog posts and papers delving into the nuances of income and payroll taxes.
Then in April 2011, Congress’s Joint Committee on Taxation released its own study of tax liability that estimated an even higher figure of nonpayers of federal income taxes dating back to 2009. For the first time in recent history, according to JCT, the majority of people paid no federal income taxes, meaning that 51 percent of Americans were off the rolls. That’s 35.5 million people. The Right went ballistic.
Sen. John Cornyn, R-Texas, gave an impassioned floor speech describing the number of people who pay no income federal taxes with words like zero, nada, zip. Hatch—whose two top tax staffers had requested the JCT report—said that the poor needed to share more responsibility for the government.
The Tax Foundation’s Hodge says, “There is growing recognition that this is a problem. The number of people who do not pay federal income taxes has undermined the ability of the Republicans to have broad-based tax reform. How do you broaden the base without raising taxes on all Americans?”
Although it’s true that the wealthy pay the lion’s share of federal income taxes, they as a group have hardly suffered financially. Since 2001, upper-income earners have received tax breaks that have allowed them to reap huge financial windfalls. Other aspects of the tax code also favor wealthy interests. Because of low taxes on dividends and capital gains, any income derived from investments (a greater source of revenue for upper-income than for middle-income Americans) gets taxed at a rate of 15 percent. Same goes for private-equity or hedge-fund managers, whose income under the carried-interest provision is taxed at 15 percent. And tax expenditures, which aid people across the economic divide, give a boost to the wealthy, who can take deductions for mortgage interest, charitable donations, and state and local taxes.
Tax and fiscal policies benefit the wealthy so much that the top 1 percent of richest Americans saw their after-tax income grow 275 percent from 1979 to 2007, according to the Congressional Budget Office. The average incomes of those in the top 20 percent rose 65 percent. In contrast, the bottom 20 percent’s average after-tax income grew just 18 percent over the same period.
In an even more eye-popping statistic, from 2005 to ’07, the after-tax income of the top 20 percent exceeded the after-tax income of the remaining 80 percent of all taxpayers—a revelation that led the typically restrained CBO to conclude that “the distribution of after-tax household income in the United States was substantially more unequal in 2007 than in 1979.”
This level of income inequality, and the Republican Party’s acceptance of it, marks a shift in its ideology from Reagan, who expanded the Earned Income Tax Credit, to today’s presidential candidates, whose fiscal plans largely revolve around permanently lowering the marginal tax rates for the rich and for corporations.
Even Mitt Romney, whom the Right views with suspicion, is eyeing the amount of income taxes that the near-poor and low-income workers pay. Late last year, Lanhee Chen, one of Romney’s policy advisers, told The Wall Street Journal that the campaign will be examining the definition of who really is needy and should benefit from government assistance.
Not all Republicans approve of the idea of paring back the Earned Income Tax Credit. Wehner, who worked for Reagan and both Bushes, says he’s “not particularly keen on” such a policy shift. “It’s a talking point on conservative talk radio,” he says. “The concern is that people who are not paying any federal income taxes creates an entitlement mentality.”
But how does this debate play in the context of the GOP’s other tax fights? During a presidential election cycle in which the economic outlook for the middle class is a key issue, what will voters think as they watch Republicans fiercely defend tax cuts for the wealthy while attacking lower-income people who pay no federal income tax?
Kies, the former House Ways and Means counsel who is now the managing director of the Federal Policy Group, a lobbying firm, says that framing the issue as raising taxes on the poor misses the point. “We’re never going to tax low-income people,” he argues. “The question is just how big the check is we’re going to send them.”
As Kies points out, the provocative 51 percent talking point is part of a larger ideological battle over the type of government the U.S. should have. Should we have a smaller federal government with lower taxes and fewer regulations that would leave people to largely take care of themselves, as Republicans generally favor? Or should the federal government help prop up the elderly, the poor, and low-income workers, as most Democrats believe? It’s a fundamental divide, writ large by the 51 percent.
“Just take Gene Sperling,” Kies says, referring to President Obama’s director of the National Economic Council. “He lives to redistribute wealth. He believes he’s doing the Lord’s work. Grover Norquist? He also believes he’s doing God’s work. Both these guys deeply believe what they’re doing is for the greater good.”
The debate over who should and will pay federal income taxes comes down to which ideology voters believe—and which party they put in power.
EQUALITY OR FAIRNESS?
In December, the Pew Research Center conducted a poll on Americans’ views of the tax system. No surprise, 59 percent said that the system is so abysmal that Congress should overhaul it. Seventy-three percent of the Democratic respondents said that the rich should pay a greater share of taxes while the Republicans’ major complaint was that the tax code is too complex.
Just 38 percent of all respondents thought they paid more than their fair share of taxes, down from 55 percent in 2000. On the issue of fairness, 43 percent called the tax system “moderately fair,” compared with 51 percent who approved of it eight years ago.
The main grievance of the tax-system-is-unfair crowd was that the wealthy are not paying an adequate amount. That was the dominant takeaway from the poll.
But just as the Democrats are crafting a message for the general election about the current economy’s income inequality, casting Obama as the protector of the middle class, Republicans are likewise concocting talking points around the concept of fairness.
In their philosophy, the idea that everyone contributes to the federal government’s tax base is an issue of equality. It’s not a shot at the near-poor or at lower-paid workers, Republicans argue. Instead, it’s a conscious move toward a flatter, less progressive system under which the rich would pay less while the middle class and the poor would pay a bit more, or at least receive less in tax refunds or benefits.
The GOP’s stance is more nuanced than the Democrats’ save-the-middle-class message. But for a country furious about the direction of the economy and frightened about safeguarding America’s place in the global pecking order, the question of fairness is not easily answered.
This article appears in the February 11, 2012, edition of National Journal Magazine.