June 21, 2013 7:27 AM
According to many pundits, the last election swung on a single quote: “There are 47 percent of the people who will vote for the president no matter what.” These writers focused on the consequences of the statement without discussing the cause. Why does nearly half of the country have no income tax obligation? The answer is Social Security. Not only is Social Security a primary cause today, but more importantly the system will continue to drive this percentage of the population higher.
This isn't an exact science, but the Tax Policy Center conducted research into who the 47% are, and how they have escaped the calculations of the IRS tax code. About half have no tax obligation because they do not make much money. So we are really looking at the 23% - those people who would pay income taxes if not for favors in the tax code.
There are two big favors in the tax code related to Social Security that reduce the income tax of Americans. Benefits from Social Security are tax-exempt; and the Earned Income Tax Credit which was created to offset the high cost of payroll taxes lowers income taxes. The research showed that between the two as much as 75% of the “23%” are removed from the tax rolls by tax treatment rooted in Social Security.
Roughly 44% of those with no income tax obligation are elderly (This group includes more than Social Security benefit exemptions. It also includes the extra standard deduction for the elderly and the credit for the elderly).
Social Security benefits enjoy a tax-exempt status that allows people to collect income on which they do not pay income taxes. All Social Security benefits are tax exempt. While the 1040 does include a portion of Social Security benefits in the tax calculation, any revenue collected is returned to the Social Security system; roughly $24 billion in 2011. This money isn’t a tax. It is really a means-tested claw-back which is collected by the IRS on behalf of the Social Security system.
Nearly 30% of those with no income tax obligation are dropped because of the EITC (and other child credits)
Many low-income workers don’t pay federal income taxes thanks, in part, to the earned income tax credit (EITC). Many in fact get a tax return because the EITC is a refundable credit. The earned income tax credit was created to offset the high cost of payroll taxes for lower-wage workers. The EITC has changed over time, but Congress in the mid-1970s decided that it was not economically viable for lower-wage workers to pay the full cost of Social Security taxes. The cost of the EITC was roughly 60 billion in 2010.
The tax base is a very complicated mix of policy and economics. Using linear research in a complicated world has its problems. It is difficult however to ignore the fact that every day, roughly 10,000 people trade in income-tax producing jobs for a pension which is completely exempt from income tax collection. It is difficult to ignore the fact that the cost of payroll taxes on lower wage Americans leaves very little room for income tax collection. Between the two, the 47% is going to rise.