There has been growing concern recently about the rapid increase in the number of “nonpayers”—those Americans who have no income tax liability because of the numerous credits and deductions in the code. As of 2010, 41 percent of tax filers—some 58 million in all—had no income tax liability after taking their credits and deductions. There are currently more Americans off the tax rolls than at any time since 1940, when the income tax became a “mass tax.”
Aside from the revenue impact of not having 58 million Americans pay income taxes, economists worry about the social and political effects of having so many people disconnected from the cost of government—a phenomenon known as fiscal illusion. The concern is that when people perceive the cost of government to be cheaper than it really is, they will demand ever more government benefits because they either don’t feel the cost directly or believe that others will be paying those costs. Indeed, when one takes into account those who do not file, about half of all households pay no federal income tax, making the situation particularly worrisome in a majority-rule democracy.
Despite these extensive concerns, there has been surprisingly little investigation of any possible linkage between the growth of nonpayers and the growth of government spending or government benefits. After tracking this trend for more than a decade, Tax Foundation economists set out to explore the fiscal consequences of the growing number of Americans being taken off the income tax rolls.
A review of the data suggests these concerns are not unfounded. Our analysis finds that in the post-WWII era, there is a very strong connection between nonpayers and federal government transfer payments. Transfer payments are programs that give direct assistance to people such as unemployment insurance, Social Security, Medicare, Medicaid, and food stamps.
In fact, our model suggests that a 1 percentage point increase in the share of tax filers who are nonpayers (from 40 percent to 41 percent, for example) is associated with a $10.6 billion per year increase in transfer payments. Since the number of nonpayers has increased by 20 percentage points over the last two decades, our model indicates that in 2010 alone, over $213 billion in transfer payments are associated with this two decade increase in nonpayers.
Further, analysis suggests that the increase in nonpayers may also be affecting other aspects of public finances such as the national debt. This is not surprising given that the growth of transfer payments has been a key driver of the growth of the national debt.