The Bailout and the Vanishing Taxpayer

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We have heard much in the press lately about the American taxpayer being forced to rescue the sharpies on Wall Street from their own greed and irresponsibility. Anti-bailout sentiment cuts “across class lines” on Main Street because “the taxpayers are on the hook for the bad judgment of others,” as the Washington Post put it.

Now for a reality check. Many Americans probably won’t pay a cent of the cost of this bailout. That’s because a rapidly increasing percentage of U.S. households legally pay no income taxes, and many others pay so little in taxes that they already get back more from the federal government in services than they send to Washington. The number of taxpayers who generate a surplus for the federal government—that is, pay more in taxes than they receive in services—is small and shrinking, which is why the only way that the folks on Main Street will pay for this bailout will be if Main Street is where the mansions are in your town.

The declining portion of households who pay taxes is a direct result of policies pursued by both Republicans and Democrats over the last 15 years or so. While deductions and credits have always served to eliminate the tax bill for some low and lower-middle income workers, from 1950 through roughly 1990, the percentage of households with no income tax burden stood constant at slightly more than one-fifth of all filers, according to the Tax Foundation. But since 1990, Washington has added all sorts of tax credits—subsidizing everything from “lifetime learning” to adoption expenses--that have further reduced the tax tab, and in the process raised the proportion of households with no federal tax liability to 33 percent.

A big culprit in this evolution is the current Bush administration and its tax packages. Although the 2001 and 2003 tax cuts are often criticized as having favored the rich, in fact they were also laden with tax credits benefiting low and middle income families, and as a result, under Bush, the percent of families not paying taxes increased more than under any other president during the last 50 years.

Both presidential candidates would vastly accelerate the trend. Barack Obama’s tax cut proposals, if enacted, would boost the proportion of those paying no income tax by one-third to a whopping 44 percent of all households, according to the Tax Foundation. John McCain’s proposal is not much different in that regard. Under his plan, 43 percent of households would pay no federal income taxes.

But even among those who still pay an income tax, only a small percent would likely be on the hook for the additional costs of the bailout. By one estimate, the federal government already spends more than $20,000 per household in direct services or services that are considered part of the ‘general good’ of the nation (like national defense). That’s a big number, that $20,000. A married couple filing jointly wouldn’t pay $20,000 in income taxes until they earned about $110,000 in taxable income--that’s income after deductions.

Of course, we pay for Washington government in more ways than simply through our personal income tax. A report by the Congressional Budget Office, Historical Effective Tax Rates, looks at our total contribution in federal taxes, including payroll and Medicare taxes, excise taxes and the share of corporate taxes that individuals pay (because we all individually bear the burden of business taxes). That study suggests that we hit the $20,000 in federal taxes mark somewhere around $95,000 in taxable income—still a big number. Of the 138 million households who file tax returns, only about 16 million, or 11 percent, earn enough to pay more to the feds in taxes than they get back in services.

The largest differences are generational, because younger and older households have less income and use more in government services than those headed by adults in their peak earning years. Thus, households consisting of adults 34-and-under and those of adults 65-and-over are a net cost to the government, while families headed by people ages 45-to-54 are the biggest net contributors, paying $1 in taxes for every 73 cents in services. It’s a good bet that middle and upper income families in that age bracket will foot a big part of this bailout bill.

On the other hand, federal legislators could decide that in light of the massive government commitment to the bailout we need to cut federal spending, which might shift some of the burden for the bailout to those who benefit from whichever programs are reduced. And the next president could determine that the country can’t afford his tax plans, and not pursue them. That might spare high-income earners from paying an even bigger part of the tab. But nothing that I’ve heard emanating from Washington suggests either likelihood.

In the end, how we actually pay for the bailout is just part of the issue. The larger point is that if McCain or Obama follow through with their tax plans, we’ll continue a trend that makes us look more and more like some European social welfare state, where many people have a stake in growing government entitlements, which fewer and fewer taxpayers finance. At some point along that road, change becomes impossible because too many citizens benefit from the system in place, while those who pay the freight for this system try whatever they can, including starting businesses elsewhere, or reducing their output, to avoid the disproportionate tax bite.

That’s a prescription for a static economy largely bereft of opportunity. On the other hand, we probably won’t have to worry about volatile markets in such a world.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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