Senator John McCain has been charging his rival, Barack Obama, with “socialism” as of late since Obama's tax plan increases taxes for "wealthy" Americans while redistributing that wealth to 95 percent of tax filers. As McCain correctly points out, 1/3 of all tax filers pay no federal income taxes at all. So if Obama plans to give all of them a tax cut and they owe zero, then he’d have to write them a check - a “hand-out,” in McCain’s terms.
This charge has perplexed me since I first heard it. Is it really true that 1/3 of us don’t owe any taxes at all come April 15? I remember filing taxes as a teenager and getting all my income tax withholding back after banking a measly couple grand, but teenagers can’t possibly make up 1/3 of the populace. Does Obama’s plan really intend to write checks to non-taxpayers?
The answers: Yes, 1/3 of tax-filers, some 45.6 million people, have no tax liability after taking their credits and deductions. This number is 57% higher than when I was last a teenager. Yes, Obama’s plan would result in hand-outs for millions. But so would McCain’s plan. And, it is already happening.
The key is in the language. They aren’t promising just “tax credits,” but “fully refundable tax credits.” While most tax credits, such as the HOPE credit and the credit for adoption expenses, can only reduce a taxpayers’s amount owed to zero, those that are refundable, like the earned income tax credit (EITC) and the child tax credit, can result in a check larger than the total amount paid in income taxes.
According to the Washington, DC based nonpartisan tax research group, the Tax Foundation, tax returns for many have become a claim form for a subsidy delivered through the tax systems rather than a direct payment from a traditional government program like welfare or farm supports. Regardless of which candidate wins, this will continue and there will be more filers owing zero or getting a payment.
Obama promises seven new “fully refundable” provisions, including a new “Making Work Pay Credit” and a “Universal Mortgage Credit.” He also plans to eliminate income taxes for seniors earning under $50,000.
But McCain should be careful about throwing stones in glass houses. He is proposing an expansion of the dependent exemption and one new refundable tax credit, a $5,000 health care tax credit.
The Tax Foundation estimates the two McCain proposals would increase the number of nonpayers by about 15 million and bring the portion of tax filers owing nothing or getting a check to roughly 43 percent. Obama’s plan features a longer list of smaller tax credits that would result in an increase of about 16 million in the nonpayer category, bringing the total to 44 percent of all tax returns.
This all started long before either of these two started running for president. Beginning in the early 1990s, lawmakers have increasingly used the tax code instead of government spending programs to funnel money to groups of people they want to reward. Want to reward child rearing? Introduce a child and adoption expense credits. Want more people in college? Enter the HOPE and lifetime learning credits. Concerned about global warming? Here is a tax credit for those who buy hybrid cars. The most significant of these socially targeted credits was the $500 per-child tax credit enacted in 1997 which was doubled in 2001 and 2003 and made refundable.
Experts see many problems with this approach. First of all, it adds a lot of complexity to the tax code, especially for low-income Americans who are the intended beneficiaries of most credits.
It also creates punitive marginal tax rates. Keep in mind that each of these credits has a phase-out range in order to withhold the benefit from the wealthy, a range of income where the taxpayer has to pay back the credit that he no longer qualifies for. This means that taxpayers in the phase-out range face unexpectedly high effective tax rates. In the case of the EITC, taxpayers in the phase-out range face a higher rate than even the most affluent Americans.
The ever narrowing number of us actually paying income taxes makes revenue volatile. A shrinking tax base requires higher taxes on everyone else and will force the government to rely more on business, dividend, and capital gains income which fluctuate much more than wages. California’s recent massive budget problems can at least be partially attributed to a narrow tax base.
Finally, substitution of tax credits for government spending dramatically expands the role of the Internal Revenue Service (IRS). These many credits have made the tax code even more obtuse for taxpayers to crack and more difficult for the IRS to administer.
While the candidates wrap up their campaigns, they are certain to continue touting the benefits of their tax plans and arguing that the other guy’s plan means the end of civilization as we know it. Don’t let them fool you. In terms of taxes, it’s just even more of the same.
Related Stories:
Related Videos:
McCain calls Obama's plan socialism, despite supporting a similar plan in 2000
Obama - McCain tax plans compared
Visual comparison of tax plans
Most Read: