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Taxes and the Poor: How does the federal tax system affect low-income households?

Low-income households pay relatively low federal taxes, primarily because tax credits reduce or eliminate their income tax liability, and some (called refundable credits) result in net payments to them. Stimulus measures enacted to offset the adverse effects of the 2008-09 recession further re-duced the tax-burden on these families. In 2011, tax units in the lowest income quintile (that is, the 20 percent of all tax units with the lowest incomes) on average paid federal income, payroll, and es-tate taxes equal to 0.8 percent of their cash income, less than a twentieth of the 18.1 percent average effective tax rate for all tax units (see table).

Taxes-and-the-Poor-updated-graph1-Average-Effective-Tax-Rates-July-2011
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Taxes-and-the-Poor-updated-graph1-Average-Effective-July-2011
  • Because the earned income tax credit (EITC) is refundable and the child tax credit (CTC) is partly so, the average effective individual income tax rate for the bottom two income quin-tiles in 2011 was negative; that is, the tax credits more than offset positive income tax liabil-ity, so that the average household in these quintiles received a net payment from the gov-ernment.
  • Low-income households face a lower than average effective payroll tax rate because they get less of their income from earnings and more from transfer payments than do higher-income households. In 2011, payroll taxes claimed 6.2 percent of the cash income of tax units in the lowest quintile, compared with 7.0 percent for all tax units.
  • Tax units in the lowest income quintile pay about the same average effective tax rate on cor-porate income (passed through to them as shareholders) than units in the next two quintiles. That outcome occurs because low-income elderly households get a disproportionately large share of their income from their retirement savings.
  • Not surprisingly, low-income households pay virtually no estate taxes. In 2011, the $5 mil-lion threshold for estate tax liability ($10 million for married couples) will exclude taxpayers in all but the highest income quintile from the tax.
  • Effective tax rates on low-income households have changed markedly over the past quarter century (see figure 1). Creation of the CTC and expansion of the EITC both served to lower the effective individual income tax rate for these households from about 0.5 percent in the early 1980s to its negative value more recently. In contrast, the effective payroll tax rate for households in the lowest income quintile increased by more than half over the same period. The effective corporate income tax rate for low-income households has also fallen since 1979, while the effective excise tax rate rose slightly.
    Taxes-and-the-Poor-graph2-Effective-Federal-July-2011
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    Taxes-and-the-Poor-graph2-Effective-Federal-July-2011
  • Low-income married couples with children have seen a marked decline in their taxes since 1970 (see figure 2). For example, the average combined income and payroll tax rate for mar-ried couples with two children and income at the poverty level fell from over 9 percent in 1970 to negative 27 percent in 2010. That decline resulted in large part from the creation and subsequent expansion of the refundable EITC and partially refundable CTC as well as the temporary stimulus measures in 2009 and 2010.
Taxes-and-the-Poor-graph3-Combined-Income-July-2011
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Taxes-and-the-Poor-graph3-Combined-Income-July-2011
 
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