Fewer taxpayers: 1 out of 3 who file returns get back more than withheld

The Tax Foundation

WASHINGTON -- When the nation's tax filing season ends April 15, almost one out of every three tax filers will get a refund so large that it returns every dollar withheld from the filer's paychecks during the year, according to a new Tax Foundation analysis.

"Many taxpayers get a refund at tax time," explained Scott Hodge, president of the Tax Foundation, "but the refund is usually a tiny fraction of what the person paid during the year. Nonpayers are those tax filers whose refunds exceed their withholding." Tax Foundation economists estimate that 32 percent of 2006's tax returns, roughly 43.4 million tax returns representing 91 million individuals, will face a zero or negative tax liability, in which case they profit from filing a tax return. That's out of a total of 136 million federal tax returns that will be filed.

Who are the nonpayers?

Most nonpayers file as single or head-of-household, not as married couples. In fact, one-third of single filers pay nothing in federal income taxes, and almost two-thirds of those who file as head of household pay nothing. In contrast, just 22 percent of married filers are nonpayers.

Single filers tend to be younger and earn lower incomes than married filers -- especially single parents who file as head-of-household. As a result, married taxpayers pay roughly 75 percent of all federal income taxes, despite filing only 40 percent of returns.

Nonpayers by state

The number of Americans who face zero federal income tax liability varies widely by state, principally for two reasons. Average household income varies by state, and those with lower-than-average incomes will have a larger share of nonpayers. Also, some states have a high number of single parents who typically file as head-of-household and whose tax liabilities are reduced through tax credits such as the $1,000-per-child tax credit and the earned income tax credit.

Even without taking into account the impact of Gulf Coast hurricanes during 2005, Mississippi (43 percent) and Louisiana (40 percent) ranked first and second with the highest percentage of their tax returns in the nonpaying category. As IRS data becomes clear for tax year 2005, their percentages of nonpayers will undoubtedly be revised upward.

The other states with the highest percentages of nonpayers are Arkansas (38 percent), New Mexico (38 percent), Alabama (38 percent), Texas (37 percent), Montana (36 percent), Oklahoma (36 percent), South Carolina (36 percent) and Georgia (36 percent).

The 10 states with the lowest percentages of nonpayers are Alaska (20 percent), Massachusetts (24 percent), Connecticut (24 percent), New Hampshire (24 percent), Minnesota (26 percent), Maryland (26 percent), Delaware (26 percent), Washington (27 percent), Rhode Island (27 percent) and Virginia (27 percent).

Tax cuts raise nonpayers

The number of tax returns with zero or negative tax liability has risen steadily over the past decade. However, it accelerated sharply between 2000 and 2004 due to the effects of tax changes during President Bush's first term of office.

As President Bush pushed through his two major tax bills in 2001 and 2003, media reports focused mostly on the dollar amounts saved by high-income individuals. At the lower end of the income spectrum, the laws were having dramatic effects, removing millions of people from the tax rolls, mostly by doubling the child tax credit.

Tax reform difficult

One of President Bush's second-term priorities was federal tax reform. However, fundamental reform requires that the base of the federal income tax be widened so that overall tax rates can be reduced. Increasing the number of Americans currently paying zero federal income tax makes any attempt to broaden the tax base a more difficult job.

The millions of Americans who have no federal income tax liability will either be indifferent about tax reform or will positively oppose it, as it would require bringing them into the federal tax base.

"These findings raise serious questions about the future of the U.S. income tax system." said Hodge. "The majority of the federal tax burden is being borne by a shrinking pool of taxpayers. As Congress considers tax reform proposals during the coming year, this is an issue lawmakers should begin to debate."

The Tax Foundation is a nonpartisan, not-for-profit organization that monitors fiscal policy at the federal, state and local levels.