Tax Day Post: Federal Tax Revenues


Today, the filing deadline for 2010 tax returns, we finish our look at tax statistics after previously examining how businesses in the construction sector pay taxes and recent policy proposals concerning the deficit and the housing tax incentives.

Individual tax revenues, which include taxes paid on income from pass-thru businesses, declined during the Great Recession but are expected to rebound with an improving economy. In 2010, as a share of gross domestic product (GDP), individual tax revenues collected by the federal government totaled 6.2% of GDP.  For 2011, the Congressional Budget Office expects them to increase to 6.6% of GDP.

As the following graph shows, these taxes have and will continue to constitute a large portion of total federal taxes collected. Total federal taxes in 2011 are expected to sum to 14.8%.

The problem is that total federal spending is expected to outpace tax collections for the foreseeable future. The graph above actually understates the fiscal challenge because it includes an automatic, significant tax increase in 2013 when the extension of the 2001/2003 tax cuts expires.

If we assume that the tax cuts are extended, along with the traditional tax extender provisions, then federal tax collections will in fact be about 2.5 percentage points of GDP lower than the chart above suggests.

This leads to structural deficit of about 5% of GDP between planned government spending and expected tax collections, assuming a present policy baseline.

It is worth noting however that even assuming permanent extension of the 2001/2003 tax cuts, federal tax collections would still be approximately 18% of GDP, about equal to the historical average. For this reason, many analysts point to increasing entitlement spending – particularly health-related spending such as Medicare and Medicaid – as the primary source of the coming fiscal challenge.

This challenge has caused and will continue to generate debate about closing the government’s structural budget gap. It is in this larger debate that calls for tax reform have been given voice. And in this context, it might be useful to look at the history of the top individual marginal tax rate since the last major tax reform effort in 1986.

The top tax rate bottomed out at 28% in 1988, a little higher than the 25% rate Congressman Ryan recently called for in his long-term budget proposal. Nonetheless, less than seven years after the 1986 exercise of lowering rates via tax base broadening, the top rate had climbed to 39.6%. This is useful to keep in mind as the budget debates continue: there is no such thing as permanent tax law. Elections, events, economics and changing policy priorities make tax law an ever-changing thing.

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