Why Some Are Exempt From Federal Income Taxes

Correction Sept. 19, 2012

We incorrectly say that military pay is not subject to federal income taxes. While some military pay is exempt from federal income taxes, there is no blanket exemption from federal taxes for members of the military.

One thing all parties seem to agree on in this latest campaign controversy is that the proportion of households not paying any federal income taxes has indeed grown larger in recent years. One key factor has been a federal subsidy for low-wage workers known as the Earned Income Tax Credit.

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Far more than half of Americans pay some form of federal, state and local taxes. But one thing all parties seem to agree on, is that the proportion of people not paying federal income taxes has grown larger in recent years.

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Less talked about is that policies backed both by Democrats and Republicans, combined with an aging population and a high unemployment rate, have fueled that growth. NPR's David Welna has this brief history of federal taxes.

DAVID WELNA, BYLINE: Mitt Romney is hardly the first Republican to complain about all the people not paying federal income taxes. GOP lawmakers have long made this an issue on Capitol Hill. Here's Jon Kyl, the Senate's number two Republican, pointing out last year that about half of U.S. households fell in that group.

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SEN. JON KYL: I don't think that's a good thing. While certainly, people in the lower-income brackets aren't able to pay very much in the way of taxes, I think even a very small amount - an affordable amount - would be appropriate so that everybody has what they call skin in the game.

WELNA: Kyl did not mention that most of those people do pay federal payroll taxes; and that half a dozen of the nation's 400 wealthiest households paid no federal income taxes in 2009, thanks to tax breaks for investment losses. But most of the 76 million houses that paid no federal income taxes last year, were anything but wealthy. Elaine Maag is an expert on low-income taxation at the nonpartisan Tax Policy Center.

ELAINE MAAG: Many people do not pay income tax - federal income taxes because they have earnings, or types of income, that we don't tax.

WELNA: Such as Social Security payments to the elderly and disabled, or military pay. [POST-BROADCAST CORRECTION: Some military pay is exempt from federal income taxes, but there is no blanket exemption from federal taxes for military members.]

But the biggest reason so many households pay no federal income tax, is the earned-income tax credit. University of Wisconsin economist John Karl Scholz says there was broad support for this subsidy for low-wage workers, when it was enacted by Congress in 1975.

JOHN KARL SCHOLZ: The Republicans were attracted to it because it reinforces work. It subsidizes the wages of low-skilled workers. Democrats, I think, liked it because it redistributed resources to households trying to do the right thing. And so for a very long time - and it was expanded in bipartisan fashion.

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PRESIDENT RONALD REAGAN: Millions of working poor will be dropped from the tax rolls altogether.

WELNA: That was President Ronald Reagan, praising an expansion of the earned-income tax credit as part of the 1986 Tax Reform Act.

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REAGAN: The bill I'm signing today is not only an historic overhaul of our tax code, and a sweeping victory for fairness; it's also the best anti-poverty bill, the best pro-family measure, and the best job-creation program ever to come out of the Congress of the United States.

WELNA: And that tax credit did do what it was intended to do, according to the Tax Policy Center's Elaine Maag.

MAAG: It was enacted to encourage people to work. The research is very good at showing that it brings people into the labor market.

WELNA: A month after taking office in 1993, President Bill Clinton asked Congress to make the earned-income tax credit more generous, especially for families with two or more children.

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PRESIDENT BILL CLINTON: By expanding the refundable earned-income tax credit, we will make history. We will reward the work of millions of working, poor Americans by realizing the principle that if you work 40 hours a week and you've got a child in the house, you will no longer be in poverty.

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WELNA: Clinton got what he asked for, and about a quarter of households paid no federal income tax during his administration. The proportion not paying increased to more than 36 percent by the end of George W. Bush's presidency - thanks, in part, to a child tax credit he added. A combination of high unemployment and temporary tax breaks, has had nearly half of all households exempt from federal income taxes in the Obama administration. But tax expert Maag says that's bound to change.

MAAG: The projections at the Tax Policy Center, that we've had for a while, note that as the economy recovers, more people will be brought into the federal income tax fold, and that number will drop by about half.

WELNA: Already, nearly two-thirds of those who don't pay federal income taxes do have a job, and pay other federal taxes. But by earning more, they'd also have to pay more.

David Welna, NPR New, the Capitol.

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