FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
April 25, 2017
44% of US Households Don’t Pay Any Federal Income Tax
1. 44% of Households Don’t Pay Any Federal Income Tax
Baupost's investment process involves "never-ending" gleaning of facts to help support investment ideas Seth Klarman writes in his end-of-year letter to investors. In the letter, a copy of which ValueWalk has been able to review, the value investor describes the Baupost Group's process to identify ideas and answer the most critical questions about its potential Read More
2. Lion’s Share of Federal Income Taxes Paid by the “Rich”
3. President Trump to Unveil Tax Cuts as Early as Wednesday
4. Despite Record Tax Revenues, Budget Deficits Remain Huge
5. Wellesley Asset Management Webinar, Wednesday, May 3
Income Tax Day came and went last week without a great deal of fanfare. Most Americans who owed income tax to the government for 2016 either filed their tax returns and paid their bill to Uncle Sam last week, or filed for an extension and paid their estimated tax, as many do each year. Nothing new there.
What you may not know, however, is that almost half (44%) of American households paid no income tax to the federal government in 2016. That’s according to the latest data from the non-partisan Tax Policy Center which were released last week. You probably didn’t hear about that since the media largely ignored it.
The fact is that just over half of all households (56%) paid all of the federal income taxes in 2016. The rest didn’t pay anything and many actually got money back from the government in the way of refunds, subsidies or other federal benefits. Does that surprise you?
This trend of a higher percentage of households paying nothing in federal income taxes is troubling. Our national debt is fast approaching $20 trillion, the largest of any nation in history. If the debt continues to increase, it spells another financial crisis in the not-too-distant future.
Today, we’ll look at the Tax Policy Center’s latest report showing that 44% of households now pay zero federal income taxes, and I’ll give you a deeper look into the 56% who still pay federal income taxes.
Next, the mainstream media continually bombards us with claims that the “rich” don’t pay their fair share of federal income taxes. This is simply not true, and has not been true for decades, as I will point out today. On the subject of income tax rates, President Trump says he will unveil his tax reform plan as early as tomorrow – I’ll have some comments below.
Finally, the White House Office of Management and Budget just released new budget deficit projections for the next five years. The result: the deficits will average over $500 billion a year during the 2017-2021 period. Details to follow.
44% of Households Don’t Pay Any Federal Income Tax
Last Tuesday, April 18, was Income Tax Day in America. That’s the date by which all Americans who owed income tax in 2016 had to either file their income tax returns and send a payment to the IRS, or file for an extension to submit their income tax returns for 2016 later this year.
Yet millions of Americans have discovered that they don’t owe Uncle Sam a dime. According to 2016 data from the non-partisan Tax Policy Center, 44.3% of American households – upwards of 76 million – didn’t pay any income tax to the federal government last year. This year that number is expected to be roughly the same.
Most of these people aren’t paying income taxes because they either don’t have any income that is taxable (many fall below the poverty line), or because they get enough tax breaks so as to not owe the government money.
Common tax breaks include the child tax credit, the earned income tax credit (EITC), and the exclusion of some or all Social Security income, explains Roberton Williams of the Tax Policy Center.
Of course, this doesn’t mean that this group is completely tax exempt. According to Williams, “Roughly 2/3 of those paying no federal income tax work and pay federal payroll taxes that support Social Security and Medicare; about 60% of the rest are elderly and thus retired and not working; and most of the rest have very low incomes.”
Lion’s Share of Federal Income Taxes Paid by the “Rich”
The mainstream media and many on the left would have us believe that the rich don’t pay their fair share of income taxes. Warren Buffet once said that he had a lower income tax rate than his secretary, thanks in part to how his investment income is taxed.
Yet the truth is that the lion’s share of federal income taxes is paid by those who are rich. While most wealthy people hire accountants and CPAs to help them pay as little tax as possible, they still pay the bulk of federal income taxes and have for years.
More than 31% of all federal individual income tax is paid by those who bring in more than $1 million a year – who have a net effective tax rate of 25.3%, the highest of any group. Another 14% of income tax is paid by those who make between $500,000 and $1 million, who have a 20% effective tax rate, the second highest.
As you can see above, the lowest 20% income group and the second lowest group both got refund checks from the government of $655 and $513, respectively, on average in 2014.
Using federal income data for 2014, the Tax Policy Center split taxpayers into quintiles based on income. Here again, we see that the lowest two quintiles received tax refunds from the government on average. At the other end, the top 20% of income earners – those making over $134,300 – paid almost 84% of all federal income taxes collected for that year.
President Trump to Unveil Tax Cuts as Early as Wednesday
President Trump said on Friday that businesses and individuals will receive a “massive tax cut” under a tax reform package he plans to unveil this week. In an interview with The Associated Press, Trump said the plan will result in tax cuts for both individuals and businesses. He would not provide details of the plan, saying only that the tax cuts will be “bigger I believe than any tax cut ever.”
The president said the package will be released on “Wednesday or shortly thereafter” – just before his 100-day mark in office. He will face opposition from Democrats in Congress, and may even have opposition within his own party.
Treasury Secretary Steven Mnuchin initially set a goal of getting tax reform passed by August, but that deadline appears to have slipped. Mnuchin now says the administration still hopes to get a bill passed well before the end of the year.
Mnuchin on Thursday said that economic growth from the proposed tax cuts would come close to $2 trillion over 10 years. “The plan will pay for itself with growth,” Mnuchin said.
Even if the White House has rosy estimates about the economic impact of the tax cuts, the administration could run into trouble as any plan moves through Congress. That’s because Congress relies on tax analyses performed by the Congressional Budget Office and the Joint Committee on Taxation, both of which tend to have a more restrained view on the macroeconomic effects of tax cuts.
President Trump believes the tax code is too complicated and tax rates are too high, and he has made overhauling the tax code one of his top priorities. But simply cutting taxes – lowering the rates that businesses and individuals pay – is difficult for lawmakers because of congressional budget rules.
Most Democrats will not support a tax plan that simply cuts tax rates, and Republicans have a narrow 52-to-48 advantage in the Senate. To pass a tax plan along party lines, Republicans have to ensure that it won’t grow the deficit beyond the first 10 years. That requires them to find new revenue to offset what they will lose by cutting rates.
Mnuchin said, among other things, that there would be some sort of “reciprocity tax” that aims to raise taxes on imports from countries that have tariffs against US imports, citing the example of automobile sales. But he declined to give more specifics.
Trump has in the past proposed cutting the corporate tax rate from 35% to 15% and cutting individual income tax rates sharply as well. He has also proposed a one-time tax of 10%-15% on corporate profits held outside the US that are repatriated.
Hopefully, we’ll have more details by the end of this week.
Despite Record Tax Revenues, Budget Deficits Remain Huge
It’s no secret that the US government has run a budget deficit, where it spends far more than it collects in revenues, every year since 2001. But what may surprise many Americans as they pay their income taxes is that the US government has already been collecting record levels of taxes this fiscal year.
The federal government collected record amounts of both individual income taxes and payroll taxes through the first six months of FY2017 (Oct. 1, 2016 through the end of March), according to the Treasury Department.
Through March, the federal government collected apprx. $695.4 billion in individual income taxes. That’s about $7.4 billion more than what the federal government collected in the first six months ofFY2016.
The federal government also collected $547.5 billion in Social Security and other payroll taxes during the first six months of FY2017. That’s about $2.7 billion more than the government collected in the first six months of FY2016.
Despite collecting record amounts of individual income taxes and payroll taxes, the Treasury still ran a deficit of $526.8 billion in the first six months of FY2017.
The chart below reveals how the U.S. government’s cumulative spending and tax collections for FY2017 compare with that for last year (FY2016).
The chart also explains why the federal government runs a budget deficit every year. At no time during the period shown does the cumulative spending of the government ever drop below the cumulative combined amount of the income and payroll taxes it withholds from American paychecks and the student loan debt payments it collects from Americans who borrowed money from the government.
Unlike the money it collects through taxes and student loan payments, where the ever-changing state of the US economy can greatly affect the incomes of taxpaying Americans, the government has full control over the amount of discretionary money that it spends.
If US politicians really wanted to get serious about improving the fiscal health of the federal US government – without imposing an even greater tax burden on regular Americans (who are already paying record amounts of taxes) – here’s how they would do it. They would take steps to more closely match the amount of federal spending to the amount of revenue that the US Treasury actually collects each month, rather than allowing spending to increase every year since 1954.
That’s right! The federal spending budget has gone up every year for the last 63 years. Here are the latest projections of the annual budget deficits for the next five years from the White House Office of Management and Budget.
The numbers for 2017-2021 are estimates, of course, and are subject to change. However, the White House’s own budget gurus are projecting annual budget deficits that average well over $500 billion for the next five years.
They obviously weren’t using President Trump’s so-called “Skinny Budget” which includes some dramatic cuts to several government agencies including the EPA. Absent such significant cuts in the size of government, our annual deficits will remain huge, and the national debt will go up another $1 trillion or so every couple of years.
The question is: Can or will President Trump do anything to stop it? That’s a discussion I’ll have to save for another time.
Wellesley Asset Management Webinar, Wednesday, May 3 3:00PM Eastern
We will host a live webinar with Michael Miller of Wellesley Asset Management on Wednesday, May 3 at 3:00PM Eastern Time. Wellesley specializes in convertible bonds which can be an excellent addition to your portfolio. Wellesley has an impressive performance record dating back over 21 years.
Unfortunately, many investors don’t understand how convertible bonds work and how they can help diversify their portfolios. Our webinar on May 3 will be an excellent opportunity to learn how convertible bonds work, and Michael will answer any questions you may have. Be sure to register for what will be one of our most informative webinars of the year.