The Fiscal Costs of Nonpayers

September 26, 2012

In 2010, nearly 41 percent of Americans, or 58 million altogether, had no income tax liability. These nonpayers took advantage of numerous credits and deductions in the tax code to exempt them from any tax liability, say Will Freeland, William McBride and Ed Gerrish of the Tax Foundation.

There are several economic and political implications of having so many people off the tax rolls:

  • A 1 percentage point increase in nonpayers results in a $10.6 billion per year increase in transfer payments-programs that give direct assistance from the government to people, such as Social Security or unemployment insurance.
  • Over the past two decades, the number of nonpayers has increased 20 percentage points.
  • In 2010 alone, over $213 billion in transfer payments can be attributed to the increase in nonpayers.
  • For every 1 percentage point increase in nonpayers, the percentage of debt of the gross domestic product (GDP) increases by 0.704 percent.
  • This has increased the debt-to-GDP ratio by 14 percentage points in 2010 alone.

The increase in nonpayers can create a phenomenon called fiscal illusion where people perceive the cost of government to be cheaper than it is and thus demand more social services. As a result, when transfer payments increase, discretionary spending on defense funding and public investments get crowded out.

There are two main reasons for the increase in nonpayers.

  • The first is the increased value of the standard deduction and personal exemption as a result of the Tax Reform Act of 1986, which reduced taxable income for all taxpayers.
  • The second has been the expansion of tax credits, which has reduced tax liability for millions of Americans.
  • The combined budgetary cost of tax credits was around $224 billion in 2010.

The biggest concern stems from the impact that increased transfer payments have on Americans. Studies show that the increase in transfer payments, and the subsequent rise in taxation, hurt a nation's growth potential and employment opportunities. This is compounded by the fact that people have less incentive to work as the transfer of payments from the government increase.

Source: Will Freeland, William McBride and Ed Gerrish, "The Fiscal Costs of Nonpayers," Tax Foundation, September 19, 2012.

 

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