The federal income tax deadline is now behind us, but taxes remain very much on our minds – whether you are awaiting a big refund check in the mail, or your bank account just suffered a big hit from your 1040 return.
Most of us feel that we pay way too much in federal taxes. So it may surprise you that our federal income taxes have actually gone down over the past half-century. And today, nearly half of U.S. households pay no income taxes at all. Jim Coyle, a tax and estate planning attorney at Stewart Melvin & Frost in Gainesville, Ga., offers insight in this area.
Question: With all this talk of the national deficit and pressure to start raising federal taxes on Americans, is it true that only half of U.S. households currently pay no income tax at all?
Jim: Yes, it is true. The Tax Policy Center, an independent Washington think tank, estimates 45 percent of U.S. households paid no federal income tax for 2010. The primary reason is that our nation’s tax laws are packed with tax breaks for people at all income tax levels. In recent years, credits for low- and middle-income families have grown so much that a family of four making as much as $50,000 will owe no federal income tax, as long as there are two children younger than 17, according to an analysis by the Deloitte Tax consulting firm. The vast majority of those who escape paying any federal income taxes at all are those with low to medium incomes. (But keep in mind that this sector still pays other taxes such as Social Security, Medicare, property taxes, and sales taxes – so it’s not a total free ride).
Question: What about the rest of Americans? Are middle-income families and the wealthy paying more in taxes to make up for those who don’t pay?
Jim: The top income tax rate is 35 percent. However, the average federal income tax rate for all taxpayers is about 9.3 percent. (That’s a decline from 9.9 percent over the past decade). Again, the reason for this lower rate is that our tax system is loaded with so many deductions, credits and exemptions. There are deductions if you have children. Paying your mortgage. College expenses. Medical expenses. Charitable contributions. Even paying other taxes. According to the National Taxpayer Advocate, an independent watchdog division within the IRS, our tax code is filled with a total of $1.1 trillion in credits, deductions and exemptions. This averages out to be about $8,000 per taxpayer.
Question: So, we’re actually paying less in federal taxes than we used to?
Jim: Correct . . . Americans are now paying federal taxes at or near historically low levels, according to the latest available data. That’s true whether it comes to your federal income taxes or your total federal taxes.
Income taxes: A family of four in the exact middle of the income spectrum will pay only 4.7 percent of its household income in federal income taxes this year, according to an analysis by the Urban Institute-Brookings Institution Tax Policy Center. This is the third-lowest percentage in the past 50 years, after 2008 and 2009.
Overall federal taxes: Middle-income households are paying overall federal taxes — which include income as well as payroll and excise taxes — at or near their lowest levels in decades, according to the latest data from the Congressional Budget Office (CBO).
Question: What about the super wealthy? With their access to lucrative tax breaks, are they paying a lower percentage of federal taxes than the rest of us?
Jim: No. The average federal income tax rate for the wealthiest Americans is about 17 percent. This percentage is higher than that for middle-income Americans but it still represents a huge drop from the 26 percent average rate that they were paying back in 1992. The wealthy certainly have access to much more lucrative tax breaks than the rest of us. But just in case you don’t think they’re paying their fair share, you might want to consider this: More than half of our nation’s tax revenue comes from the top 10 percent of earners. These statistics on the super wealthy are cited by the IRS, which tracks the tax returns of the 400 highest adjusted gross incomes. The average income on those returns for the 2007 tax year (the latest year for IRS data) was nearly $345 million a year.
Question: So if everyone across the board is paying less in taxes, what are we going to do about our huge federal budget deficit?
Jim: That’s a question for Washington and the politicians. However, it’s fair to say that both sides of the aisle – Republicans and Democrats – are calling for our tax laws to be overhauled. And it’s certainly true that our large federal budget deficit is the key motivation.Each party has a different idea of how to accomplish this.
House Republicans want to reduce the tax rate ceiling from 35 percent down to 25 percent, but eliminate a majority of the tax breaks. Their argument is that a more efficient tax code would stimulate economic activity, which would lead to additional tax revenue.
Meanwhile, President Obama on the Democrat side also has called for an overhaul of the tax code by lowering rates and eliminating tax breaks. But his plan would raise taxes on high-income taxpayers, starting with his proposal to allow tax cuts on this sector to expire by 2012.
Taxes and our nation’s multi-trillion dollar budget deficit are perhaps the biggest issue right now in Washington. And it’s unlikely to be resolved anytime soon. Many of our biggest tax breaks – like the one for paying the mortgage interest on your home that impacts over 35 million taxpayers – are near and dear to American families at just about every income level.
So, it is going to be difficult for politicians to touch these tax breaks – and enact big changes to our tax code – without upsetting their constituents at every level of income. We are likely to hear much more on this subject over the next several months leading up to the next presidential election in November of 2012.