This Congressional Budget Office (CBO) paper, prepared at the request of the Ranking Members of the Senate Budget Committee, the Senate Finance Committee, the House Budget Committee, the House Ways and Means Committee, and the Joint Economic Committee, examines how effective federal tax rates will change over the coming decade under current law--that is, if the provisions of tax laws enacted in 2001, 2002, and 2003 phase in, phase out, and "sunset" as scheduled. The paper uses the same methodology that CBO employed in its earlier estimates of effective tax rates, most recently in Effective Federal Tax Rates, 1997 to 2000 (August 2003) and Effective Federal Tax Rates: 1979-2001 (April 2004).

Under current law and the assumption that incomes grow at a constant rate, the overall effective federal tax rate drops from 21.5 percent in 2001 to 19.6 percent in 2004. It then rises irregularly over the subsequent decade as tax provisions phase in and out. In particular, the rate jumps to 21.4 percent in 2005 with the expiration of most provisions of the 2003 tax law, climbs slowly over the succeeding five years to 22.1 percent in 2010, jumps again to 23.6 percent in 2011 following the sunset of the 2001 tax law, and then rises again to 24.1 percent in 2014. The increases in the effective tax rate between 2005 and 2010 and between 2011 and 2014 occur primarily because rising real incomes move taxpayers into higher tax brackets and the alternative minimum tax affects more taxpayers over time.

Although the basic analysis of this paper takes actual incomes in 2001 as its starting point, it tests the effect of that choice of a starting point by also beginning with the higher incomes of 2000. The difference has only a small effect on the findings, most of which is attributable to the different levels of capital gains realized in those two years. Because realized gains in 2001 were closer to their historical average (measured relative to national income), tax rates based on incomes that year may more accurately represent the impact of current tax law over the coming decade.

Ed Harris, David Weiner, and Roberton Williams of CBO's Tax Analysis Division wrote the paper under the direction of G. Thomas Woodward. John Skeen edited the manuscript, and Christine Bogusz proofread it. Maureen Costantino designed the cover and prepared the report for publication. Lenny Skutnik produced the printed copies, and Annette Kalicki prepared the electronic versions for CBO's Web site.

Douglas Holtz-Eakin
Director
August 2004