So What's Our Revenue Situation?

Apr 8, 2010 | Taxes

With tax day fast approaching, it's worth discussing the current state of revenues in the United States. Last year, revenue collection hit a 60-year record low of 14.8 percent of GDP -- which was enough to pay for only 60% of what we spent.

Importantly, this revenue dip will be a temporary one -- caused by the precipitous drop in wages (including due to unemployment), capital gains, and corporate profits resulting from the recession, as well as a number of temporary tax cuts ("stimulus") designed to help the economy rebound.

In 2007, before the economic crisis, we were raising 18.8 percent of GDP, and by 2020, under the President's budget, we will be raising 19.6 percent.

[chart:2470]

These revenue levels are above the historical average (see more discussion about this here) -- a little over 18 percent -- but well below other developed countries. More importantly, revenues are projected to remain considerably lower than spending. That means we'll need spending cuts, tax increases, or more likely both.

Over the next few days, we will be discussing different ways to raise more revenue -- and the costs and benefits of these different options. For now, it is worth simply understanding where revenue comes from. Nearly all revenue came from individual income taxes (45%), corporate income taxes (12%), and payroll taxes (36%) in 2008. Remaining revenue comes from estate and gift taxes, fees and fines, tariffs, excise taxes, and other sources. (Revenue from excise taxes will increase as the health care bill is fully implemented.)

[chart:2486]

Overall, the income tax is quite progressive -- the top fifth of earners pay over 90% of taxes and the top percentiles pays 36%. In 2009, these earners paid income taxes equal to 13% and 18% of their incomes, respectively. By comparison, the average effective income tax rate is 8%, and nearly half of all taxpayers had no (or negative) net income tax burden at all. Payroll taxes are far flatter, and in fact are regressive on the top-end since workers pay no Social Security payroll tax on income over $107,000.

Whether the tax code should be more or less progressive is an open question, depending what one believes to be the appropriate distribution of income and the extent to which they want to use the tax code (or public policy more generally) to get there.

Distributional issues aide, though, most experts believe the current code is in many ways broken. The complexity of the code makes tax preparation costly in terms of time and money; hundreds of deductions, credits, and exclusions narrow the tax base and distort behavior; and higher than necessary corporate and individual rates tend to discourage work and investment, while reducing international competitiveness. Meanwhile, we still have no solution for dealing with the Alternative Minimum Tax, which is "patched" each year so as not to hit middle-class earners. And at the end of 2010, all of the 2001/2003 tax cuts are scheduled to expire.

On top of this all, we don't raise enough revenue to pay our own bills -- and even if politicians allow the tax cuts to expire (they almost certainly will not), this structural imbalance will not disappear.

So what do we do? We'll be discussing just that question over the next week.