April 16, 2010

April 16, 2010 | Commentary on Taxes

Tax Day Or Pay Day

Another Tax Day, another check to Uncle Sam. Right? More and more, though, that isn't the case. Indeed, a growing number of taxpayers pay no income tax whatsoever. And because of increasing pressure to expand government even faster than the unsustainable path it's already on, the United States is on a glide path toward an economic meltdown. According to the Tax Foundation, the number of taxpayers that had no federal income tax liability increased 45 percent between 2001 and 2008.

The number of "non-payers" now stands at 52 million. These non-payers have no interest in controlling the size of government.

Why shouldn't they demand more services if they share in none of the costs? But if the growth in the number of non-payers continues on its current trajectory, we could soon reach a dangerous tipping point. The bottom 50 percent of taxpayers now pays less than 3 percent of all income taxes. Their already small share has been declining for years. If recent trends continue, combined with recent policy changes, it's likely that when the data for this year come out, we could be at the point where more than 50 percent of taxpayers pay no income taxes. Past that point, a majority of taxpayers can vote themselves a larger and larger share of government benefits at no cost to themselves. And a large part of government spending would be financed entirely by a shrinking minority of taxpayers.

If this scenario were to occur, politicians would have no incentive to restrain government spending. After all, more votes could be won by ramping it up even faster. This deadly recipe for never-ending increases in government spending will lead inevitably to fiscal implosion when there are no longer enough productive taxpayers to foot the bill for the expanding welfare state. Why are taxpayers falling off the rolls at an increased rate? Because of new and expanded tax credits that both political parties are fond of handing out. But credits are not only wiping out the tax liabilities of millions. They are expanding the number of families dependent on the government for income. In fact, not only does the bottom 50 percent of taxpayers pay almost no taxes, many of them actually receive income through the tax code because of refundable credits. For these families, Tax Day is now payday.

In 2010, the three largest refundable credits - the Earned Income Tax credit, the Making Work Pay credit and the Child Tax credit - will redistribute more than $114 billion to the families that claim them. Most of the credits that are knocking millions off the income tax rolls and redistributing cash through the tax code have been on the books for years. But President Obama's agenda doubles down on these provisions and makes an already bad problem worse. The stimulus already created a huge new refundable credit (Making Work Pay) and expanded several others to increase dependency on the tax code.

The president's plan to raise tax rates on those making more than $250,000 a year will further decrease the share of taxes paid by the bottom 50 percent and move us faster to the inflection point where more than 50 percent of taxpayers pay nothing. We must take action so that that point is never crossed. But it won't be easy. Many taxpayers have grown accustomed to not paying taxes and getting payments through the tax code. Bringing them back onto the tax rolls and taking away their subsidies will be a difficult political problem. But if current trends continue, increasing dependency will threaten the vitality of our economy, and government spending will spiral even faster out of control. The choice should be easy.

To start, Congress should immediately stop creating new credits - especially refundable ones - that will knock more taxpayers off the tax rolls. They also should extend the 2001 and 2003 tax cuts for all taxpayers. Permanently extending the cuts would avoid shifting even more of the tax burden to top-earners.

These steps will only buy Congress time, though. It also needs to move quickly to fundamentally reform the tax code to eliminate all credits that are not justified according to sound policy principles. That way at least a sizeable majority of taxpayers will have some incentive in keeping the size of government under wraps.

Congress should act soon. If it does nothing to stop the growth of dependency and non-paying taxpayers, restraining the growth of government will become next to impossible. And those of us that do still pay taxes will have an even worse Tax Day next year - and for years to come.

About the Author

Curtis S. Dubay Research Fellow, Tax and Economic Policy
Thomas A. Roe Institute for Economic Policy Studies

First appeared in McClatchy