The federal government collects revenues through individual income taxes, corporate income taxes, social insurance (payroll) taxes, excise taxes, estate and gift taxes, customs duties, and miscellaneous receipts. Individual income taxes are the largest source, producing about half of all revenues and, in recent years, raising between 8 percent and 10 percent of gross domestic product. Social insurance taxes (mainly for Social Security and Medicare's Hospital Insurance) are the second largest source of receipts, making up about a third of total revenues and a little less than 7 percent of gross domestic product. Corporate income taxes contribute about 10 percent to overall revenues and represent approximately 1 percent to 2 percent of GDP. Revenues from other taxes and duties and miscellaneous receipts make up the balance, constituting about 1.5 percent of GDP.
 

The Past 50 Years

In the past half-century, total revenues have ranged from 16.1 percent to 20.8 percent of GDP, with no obvious trend over time (see Figure 5-1). On average, their share of GDP has hovered around 18½ percent. During that period, however, the various sources of revenue have changed in importance. The contribution to overall revenues made by excise taxes and corporate income taxes has declined fairly steadily, from a combined share of more than 8 percent of GDP in 1953 to less than 3 percent today. At the same time, social insurance taxes as a percentage of GDP have grown from about 2 percent to nearly 7 percent. The share of individual income taxes has varied from 7.1 percent to 10. 3 percent of GDP and has shown a slight upward trend.
 

Figure 5-1.

Sources of Federal Revenues over the Past 50 Years

(Percentage of GDP)

Source: Congressional Budget Office.

Much of the variation in the composition of total tax revenues has been legislative in nature, as policymakers have altered tax rates and other characteristics of the tax system. However, some of that variation has resulted from the interaction between the tax code and changes in the economy. For example, excise tax receipts tended to decline over time as a percentage of GDP because many are specific levies (such as cents per gallon of gasoline) and so diminished in importance as the economy experienced inflation. In contrast, income tax receipts tended to increase relative to GDP when inflation caused various thresholds in the income tax system to decline in real (inflation-adjusted) terms and therefore boosted the amount of income subject to taxation at higher rates. Over the years, legislators have often changed those parameters of the tax system to try to offset the impact of such economic changes on taxes. In the case of the individual income tax, much of the system was eventually indexed to prevent inflation from raising that levy's share of GDP. Yet without adjustments, a host of characteristics of the current tax system continue to interact with economic conditions and cause receipts to grow faster or slower than GDP.
 

Potential Futures for Federal Revenues

As in the past, all sources of revenue will continue to be subject to legislative discretion over the long term. However, in the absence of such discretion, the individual income tax system has the most potential to change the ratio of revenues to GDP because of the various ways in which its structure interacts with the economy.

First, that system is progressive, which means that households with higher incomes are taxed at higher rates. Consequently, as GDP--and thus individual incomes--grow, a larger and larger proportion will be subject to higher tax rates. The growth of income will both increase the amount of income taxed at the highest rates and decrease the amount of earned income tax credits claimed on low-income tax returns. Because much of the tax system is indexed for inflation, that phenomenon will occur primarily with respect to real GDP growth. But some effect from inflation on the parts of the regular income tax system that are still not indexed will cause additional, although modest, increases in receipts relative to GDP over the next 50 years.

Second, the individual income tax system includes an alternative minimum tax, which subjects more taxpayers and a greater fraction of income to higher rates as GDP grows. The AMT is a parallel income tax system with fewer exemptions, deductions, and rates than the regular income tax. Households must calculate their tax liability (the amount they owe) under both the AMT and the regular income tax and pay the higher of the two.⁽¹⁾ The AMT is not indexed for inflation; therefore, sustained inflation causes it to affect more taxpayers (as nominal income rises over time) and to claim an ever-larger share of GDP.

Third, current tax law provides for rates to increase in 2011. Most of the various tax cuts legislated in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) are scheduled to expire at the end of 2010; the rest expire even sooner. As the tax code reverts to prior law, tax rates will rise, some credits will shrink, and thresholds for certain rates will shift. Those changes will increase the level of receipts as a share of GDP, both immediately and in the future.

Fourth, over the next 50 years, the Treasury will receive some tax revenues that have essentially been deferred. Contributions to retirement plans, such as 401(k) and individual retirement accounts, and contributions to employer-sponsored defined-benefit plans are tax-exempt when they are made. The income earned on assets in those accounts is also exempt. Those sums will become a rising portion of taxable income as the baby boomers retire, which will tend to boost receipts relative to GDP.

At least one factor will move receipts in the other direction, however, causing individual income tax revenues (as well as revenues from Social Security and Medicare payroll taxes) to shrink as a percentage of GDP during the next half-century. The share of employees' compensation that is paid in the form of wages and salaries (which are subject to income and payroll taxes) is projected by the Congressional Budget Office to decrease over time, in part because of the rising costs of nontaxable fringe benefits, such as employer-paid health insurance. That declining share will reduce taxable income and therefore tax revenues relative to GDP.
 

Illustrative Revenue Paths

The long-term budget scenarios outlined in Chapter 1 assume one of two possible paths for revenues, based on different approaches to tax policy. One approach is to enact a series of legislative changes that would keep receipts close to their historical average share of GDP. That outcome could be achieved either through changes in the individual income tax system or through shifts among the various types of taxes. Consequently, the first path is one in which receipts remain steady at 18.4 percent of GDP--the average of the past 30 years--beginning in 2012 (see Figure 5-2). That percentage is the level that would result if the provisions of EGTRRA and JGTRRA were extended and the AMT was indexed for inflation beginning in 2005.
 

Figure 5-2.

Total Federal Revenues Under Alternative Paths, 2003 to 2050

(Percentage of GDP)

Source: Congressional Budget Office.

Note: The historical-average values are based on 30-year historical averages, beginning in 2012.

The second path is an extrapolation of current law. It assumes that the provisions of EGTRRA and JGTRRA expire (or "sunset") as scheduled, that policymakers do not modify the AMT, and that no changes are made in tax law to slow the automatic increase in taxes that results from the interaction of economic growth and the progressive structure of the income tax. Although there is some tendency over the long term for taxable wage and salary income to decline as a proportion of compensation, the overwhelming effect of the tax system's current-law features is to raise receipts relative to GDP. Consequently, receipts rise to 24.7 percent of GDP by 2050 in the current-law path and are 6.3 percentage points higher than in the historical-average path.

Details of the Current-Law Path

In the current-law path, the individual income tax is responsible for the rise in revenue relative to GDP. Two of the factors that drive the increase in individual income tax receipts as a share of GDP are currently the subject of considerable legislative interest: the scheduled expiration of EGTRRA and JGTRRA and the mounting effects of the AMT. Those factors are worth examining in more detail.

Comparing the current-law path with one in which EGTRRA and JGTRRA are permanently extended highlights the sunset aspects of the two laws (see Figure 5-3). The expiration of EGTRRA and JGTRRA contributes a bit more than 1 percentage point of the higher receipts-to-GDP ratio in 2015, declining to a bit less than 1 percentage point in 2050. The explanation for that ebbing effect lies in the AMT. As more and more taxpayers become subject to the AMT, the tax increases triggered by the sunset of EGTRRA and JGTRRA affect fewer and fewer taxpayers.
 

Figure 5-3.

Individual Income Tax Liabilities Under Current Law or with a Permanent Extension of EGTRRA and JGTRRA, 2003 to 2050

(Percentage of GDP)

Source: Congressional Budget Office.

Note: EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; JGTRRA = Jobs and Growth Tax Relief Reconciliation Act of 2003.

The AMT can be modified in various ways, each of which yields a different measure of its effect. For the purposes of illustration, CBO measured the impact of that tax relative to a policy change in which the higher AMT exemption for 2004 enacted in JGTRRA is made permanent and all AMT parameters are indexed for inflation beginning in 2005 (see Figure 5-4).⁽²⁾ If the lower marginal tax rates in EGTRRA and JGTRRA were not extended, inflation would have only a small effect on the AMT in 2015. Over time, however, inflation has a three-pronged effect: it makes more taxpayers subject to the AMT, it causes a smaller proportion of their income to be exempt from the tax, and it pushes more taxpayers into the higher AMT tax brackets. Consequently, by 2050, the effect of inflation on the AMT under current law will make receipts as a share of GDP about 3 percentage points higher than they would be if the AMT was indexed.
 

Figure 5-4.

Individual Income Tax Liabilities Under Current Law or with the AMT Modified, 2003 to 2050

(Percentage of GDP)

Source: Congressional Budget Office.

Note: AMT = alternative minimum tax.

Taken together, the expiration of EGTRRA and JGTRRA and the effect of inflation on the AMT will raise receipts as a share of GDP by about 2 percentage points in 2015, CBO estimates (see Figure 5-5). In 2050, their combined effect will enlarge that share by about 4½ percentage points. The simultaneous effects of inflation on the AMT and the expiration of EGTRRA and JGTRRA exceed the sum of the effects of each factor individually because the two sets of effects interact. With lower tax rates in place, as provided for in EGTRRA and JGTRRA, the AMT will affect more taxpayers than it would if the old tax system were in place. Similarly, without an AMT, the tax reductions in EGTRRA and JGTRRA would have a greater impact.
 

Figure 5-5.

Individual Income Tax Liabilities Under Three Policy Alternatives, 2003 to 2050

(Percentage of GDP)

Source: Congressional Budget Office.

Note: EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; JGTRRA = Jobs and Growth Tax Relief Reconciliation Act of 2003; AMT = alternative minimum tax.

If those two tax laws are made permanent and the AMT is modified, the remaining increase in receipts as a share of GDP will be largely attributable to the progressive rate structure of the tax system. The growth of GDP and its effects on the rates at which income is taxed will increase that share by 2 percentage points by 2050 compared with the share that would result if individual income tax receipts remained steady relative to GDP. Most of that 2 percentage-point increase is commonly referred to as "real bracket creep" by analogy to the bracket creep that used to occur as a result of inflation before the tax system was indexed. But because even a low annual rate of inflation amounts to a significant increase in prices over 50 years, some of the effect shown in Figure 5-5 is attributable to inflation's effects on the remaining unindexed provisions of the tax code. If, in addition to extending EGTRRA and JGTRRA and indexing the AMT, policymakers indexed the tax code to the growth of real income, much of the remaining difference between the current-law and historical-average paths would disappear.

Implications of the Current-Law Path

Continuation of current law would raise receipts relative to GDP. In the process, it would have important implications for taxpayers: more households would have to pay income taxes, more of those households would be subject to higher tax rates, and a smaller proportion of each household's income would fall in the lower and zero tax brackets than is currently the case.

The effect of the AMT on taxpayers would be especially significant. By 2050, roughly 20 percent of individual income tax liability would be generated by the AMT, compared with about 2 percent today (see Figure 5-6). However, roughly 70 percent of the nation's households would be subject to the AMT in that year, a dramatic increase from the current 2 percent. Clearly, the AMT's contribution to receipts, although large, gives little indication of the number of people affected by the tax. The reason is that taxpayers would still have to pay the regular income tax, but an increasingly large number would also have to pay a smaller, additional AMT.
 

Figure 5-6.

The AMT's Impact on Individual Income Tax Liabilities Under Current Law, 2003 to 2050

(Percent)

Source: Congressional Budget Office.

Note: AMT = alternative minimum tax.

Real bracket creep in the current-law path would move more income into higher tax brackets. The share of total taxable income taxed at the regular rates of 15 percent and 28 percent is projected to fall from just over 75 percent in 2013 to 66 percent by 2050. As a result, by that year, 11 percent of income would be taxed at the higher rates of 31 percent, 33 percent, 36 percent, and 39.6 percent.

Real income growth would also substantially reduce the role of many tax preferences. For example, over the next 50 years, the share of households with income low enough to claim the earned income tax credit would fall from about 14 percent of tax returns to 5 percent. The share of returns claiming the child tax credit would also plummet, from 18 percent to less than 1 percent. In addition, inflation and real wage growth would affect the threshold at which Social Security benefits became subject to taxation, because that threshold is not indexed. As a result, the proportion of total Social Security benefits that are taxed will rise from 19 percent today to 38 percent by 2050.

Other Taxes

As noted above, CBO projects that payroll tax receipts will decline slightly over the next half-century because of the reduction in the share of compensation paid as taxable wages and salaries. That decline, though noticeable, is small (see Figure 5-7).
 

Figure 5-7.

Individual Income Taxes and Payroll Taxes Under the Current-Law and Historical-Average Scenarios, 2003 to 2050

(Percentage of GDP)

Source: Congressional Budget Office.

Note: The historical-average values are based on 30-year historical averages, beginning in 2012.

Other taxes will also tend to change under current law, but CBO does not explicitly address them in this analysis. Unless altered by legislation, excise taxes will tend to decline in importance. Estate and gift taxes, under the assumption that EGTRRA expires, will tend to rise as the real value of estates increases with higher levels of income and wealth. The 50-year course of corporate taxes is difficult to speculate about, even assuming no changes in tax law. Because the corporate tax rate structure is basically flat, there will be little effect from bracket creep. But at the same time, some long-term erosion has occurred in the amount of corporate income that is subject to taxation.

For the purposes of this analysis, CBO assumes that revenue sources other than the individual income tax and payroll taxes remain constant as a percentage of GDP. Since those other sources will collectively respond to the growth of income in either offsetting or unknown ways, that assumption is probably a reasonable approximation of the likely outcomes over the long run.