The Tax Policy Center has updated its estimate of the percentage of Americans who pay no federal individual income taxes. And the number is: 44 percent in 2018—about 2 percentage points above last year. The share of non-payers will drop steadily until the individual income tax provisions of the Tax Cuts and Jobs Act (TCJA) expire after 2025, causing a 2-percentage point drop.
While the share of households paying no federal income tax will increase, nearly all those households will continue to pay some taxes— whether federal payroll taxes, federal excise taxes, or state taxes.
The large percentage of people who don’t owe federal income tax is a feature, not a bug, of the revenue code. By design, the federal income tax always has excluded a significant fraction of households through a combination of personal exemptions, the standard deduction, zero bracket amounts, and more recently, tax credits.
Passage of the TCJA was the main cause of the 2 percentage point jump in non-payers of the federal income tax. The law’s increase in the standard deduction and its expansion of the Child Tax Credit (CTC) were the main drivers of this result. However, the effects of those changes were dampened somewhat by the elimination of personal exemptions.
The fraction of non-income-tax-payers grew for those in all but the top quintile, and by the largest amount (3 percentage points) among middle-income households.
Due to real income growth over time, the share of those who don’t pay federal income tax will steadily decline by roughly half a percentage point-a-year until the TCJA’s individual provisions expire in 2025. In 2026, the share of those paying no income tax will drop by 2 percentage points.
In 1913, when the modern income tax was established, very few people paid federal income taxes. The original personal exemption for married couples was $4,000, roughly $100,000 in today’s dollars. The exemption dropped to $2,000 in 1917 (about $25,000 today) but a new $200 exemption for dependents was added. The exemption was further reduced during World War II, increasing the number of households paying the income tax to help fund the war effort. After WW II, the exemption amount declined steadily in real terms until it was indexed for inflation starting in 1985 and ultimately eliminated in 2018 by the TCJA. This decline was offset first by the introduction of the standard deduction and, later, by new tax credits largely for low- and middle-income families with children, such as the Earned Income Tax Credit (EITC) and the CTC.
Of course, nearly all of those who pay no federal income tax do pay other taxes. As our former TPC colleague Roberton Williams pointed out, a majority of those non-payers work and thus also pay the payroll taxes that help support Social Security and Medicare. About three-quarters of American households pay federal income taxes, payroll taxes, or both. And almost all of those who owe no federal income tax do pay state income taxes, sales taxes, excise taxes, and/or property taxes.
TPC estimates that about 65 percent of those who pay no federal income taxes owe payroll taxes. Of those who work, two-thirds will have payroll tax liability in excess of any refundable income tax credits. Thus, only about 9 percent of households have their payroll tax fully (or more than fully) offset by those refundable credits.
Refundable credits (e.g., EITC, CTC) make it possible for some low-income parents who workers to have no net combined income and payroll taxes. These tax credits help prevent many households from being taxed into poverty.
