45% don't owe U.S. income tax

Who pays income taxes? By Jeanne Sahadi, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) -- The fastest way to make the tax-averse incensed is to tell them that nearly half of U.S. households end up owing no federal income tax when all is said and done.

But like most statistics, it is often misunderstood -- and, in the case of those trying to stir political outrage, misrepresented.

For tax year 2010, roughly 45% of households, or about 69 million, will end up owing nothing in federal income tax, according to estimates by the nonpartisan Tax Policy Center. Some in that group will even end up getting paid money from the federal government.

That does not mean such households end up paying no taxes whatsoever. For instance, those in the group still pay other taxes such as state and local income taxes, as well as property and sales taxes.

And the group doesn't necessarily get off scot-free when it comes to payroll taxes -- which support Social Security and Medicare.

More than two-thirds -- or 49 million of the 69 million households -- pay payroll tax. Of those, 34 million end up paying more in payroll taxes than they get back on their federal return. The other 15 million pay payroll tax but they get enough refundable credits to offset what they paid. (Get a 'receipt' for your taxes)

Contrary to what many assume, membership in the group isn't restricted to the poor.

It's true that the vast majority of the 69 million households make less than $50,000 -- with very heavy representation among households making less than $30,000.

But nearly 5 million households in the group make somewhere between $50,000 and more than $1 million. The vast majority of that group -- 4.3 million -- make between $50,000 and $100,000. Another 485,000 make between $100,000 and $500,000. And the remaining 18,000 make $500,000 or more

Very high-income households can fall into the non-payer group if they get their income from tax-exempt bonds or overseas sources for which they get foreign tax credits, according to Roberton Williams, a senior fellow at the Tax Policy Center.

Other data from the IRS show that the tax bite on the very highest income taxpayers has fallen as their incomes have risen. In 2007, the top 400 individual tax returns had an average adjusted gross income of $345 million, up from $47 million in 1992. But their average tax rate was just 17%, down from 26% in 1992.

How did we get here?

The ranks of those whose federal income tax burden nets out to zero -- or less -- have grown in recent years for two reasons.

The first is temporal.

The downturn in the economy has hurt household incomes and various stimulus bills offered Americans temporary tax breaks to mitigate the economic pain -- thereby further reducing their tax bills.

The second is more systemic.

The tax code is filled with hundreds of tax breaks to encourage economic activities the government favors, tax experts say. For instance, the law offers credits to supplement the wages of low-income workers, help families pay for college and encourage them to buy homes and have children.

Temporary tax policies, such as the Bush-era tax cuts and the tax breaks passed under President Obama, have also increased the ranks of the non-payers.

If most tax breaks were removed, the Tax Policy Center estimates, the percentage of households with no federal income tax liability would drop to 27% from 45%.

Why the tax-free matter

The question of who pays and who doesn't is not a trivial matter. And Washington policymakers may soon start to deal with the issue in a more explicit way as the national debate over how to rein in future deficits kicks into high gear.

Obama's bipartisan debt commission, for instance, has recommended that reforming the tax code can help not only with deficit reduction but with creating a simpler, more modern, and economically efficient tax system. (Take CNNMoney's debt quiz)

Since the hundreds of tax breaks on the books reduce federal revenue by an estimated $1.1 trillion every year, the debt panel suggested eliminating most if not all of the credits, deductions and personal exemptions, and use the newfound revenue to do two things: pay for lower income tax rates and help reduce deficits.

Generating bipartisan support for tax reform is easy. But getting to "yes" on the details and figuring out who should pay more, less or nothing at all will be a much tougher fight.

But it's a fight lawmakers are gearing up to have. To top of page

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