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Economic Insights

Over time, how has the mix of U.S. government revenues shifted among individual, corporate, and payroll taxes? This is the second of two parts.

This week’s discussion is the second half of a look at the federal budget. Together, both parts should give readers perspective on who supports the government and how the government disposes of that support. Last week’s discussion looked at outlays, showing that entitlements entirely dominate spending, and that unless there is reform, they could squeeze out most other government priorities. This week’s discussion looks at the revenues. It shows how Washington for some time now has shown a reluctance to increase its total tax take from the economy, relying on sometimes huge deficits to make up the shortfall from spending. The government has, however, shifted the incidence of tax burdens, a trend the president’s latest budget plans to halt in coming years.

Revenues Overall    
The historical record is clear. For 35 years after World War II, Washington took revenues from the economy at a faster rate than the economy grew. Right after the war, the tax take did decline, falling from more than 20% of the gross domestic product (GDP) during the conflict to a low of 14.1% of GDP in 1950. It rose again with the Korean War and fell afterward, but never back to the 1950 rate. By 1960, total revenues had risen to 17.3% of GDP, and by 1969, they touched 19.0%, after which the relentless rise all but stopped.1              

It would seem from the record that a tax take approaching 20% of GDP is about as much as the American public will tolerate. Accordingly, the proportion of GDP taken in revenues ceased rising in the 1970s. The decade closed with the take still at about 19.0%. Ronald Reagan’s promised tax cuts took the total down to about 17.0% of GDP by the late 1980s, giving George H.W. Bush leeway to raise taxes to meet Washington’s ever growing demands for financial and economic resources, a step that Bill Clinton built on in the early 1990s. These increases brought revenues again up toward 20% of the economy in 2000, the last year of Clinton’s second term. Little wonder, then, that the budget showed a surplus. The market bust that followed, and then the Bush tax cuts, brought the tax take down again, to about 17.5%, during the last years of Bush’s time in office. Revenues fell further, to 14.6% of GDP in 2008–09, less because of policy then from the Great Recession’s impact on income and profits. But tax increases under President Obama and a modest cyclical recovery began to push the tax take up again.  Still, the 2014 percentage of GDP, at 17.3%, remains below the practical ceiling of 20%.       

The White House’s budget projections indicate plans to push toward this practical ceiling. Total revenues are expected to grow 7.1% a year over the next five years, far faster than the official 5.1% projection of nominal GDP growth. The difference should bring the revenues take up to 18.6% of the GDP by 2019. Whether that evokes another round of relief is up to the voters, and is anyone’s guess, especially now.

The Mix        
Though Washington derives revenues from a broad array of taxes and fees, it has relied primarily on four sources: individual income taxes, corporate income taxes, payroll levies, and excise taxes. The mix has varied tremendously over time. 

Individual income tax burdens show the most steady pattern. They, like the total, rose as a proportion of both GDP through the 1950s and 1960s, and, unlike the total, continued to rise relatively through 1970s, going from 5.6% of GDP (about 40% of all revenues) in 1950 to a high of 9.0% in 1982 (48.2% of all revenues). The Reagan tax cuts offered a reprieve in the mid-1980s, but individual income taxes, like overall revenues, were again rising relatively later in that decade and in the 1990s, outpacing nominal GDP growth, so that by the end of the century, they were again above 9.0% of the economy (just less than 50% of all revenues). The Bush tax cuts created another pause, but individual income taxes have again risen relatively with the Obama rate increases and the economic recovery’s impact on the progressive code. They should reach 8.0% of GDP this year (and constitute 46.2% of all revenues). The White House budget plans to increase individual income taxes a rapid 8.1% a year for the next five years, fast enough to push them to 9.2% of GDP (some 48.4% of all revenues) by 2019.    

Corporate and payroll taxes, as well as excise taxes, have shown huge relative swings. In the 1950s, for instance, a legacy of heavy wartime taxes on profits, including what Washington called an “excess profits tax,” brought corporate income taxes to almost a third of total federal revenues and equal to almost 5% of the country’s GDP. During those years, payroll taxes for Social Security and what the Treasury calls “social insurance” constituted barely 10% to the government’s total revenue take and amounted to less than 2% of the total economy. Excise taxes, mostly tariffs, constituted almost 20% of Washington’s total tax take, more than 2.5% of GDP. These burdens switched dramatically in succeeding years. The growth in the welfare state made greater demands on payroll taxes, while tariff cuts drove down excise taxes and international competition did the same to corporate taxes. By 1992, as Bill Clinton took office, the switch was complete. Corporate taxes contributed less than 10% of the overall federal revenues take (1.6% of GDP), excise taxes constituted 4.2% (0.7% of GDP), and payroll taxes had risen to almost 38% of the total revenues take (6.4% of GDP).

These trends have stabilized during the Obama administration, probably less from explicit policy than because they had proceeded about as far as they could go. Payroll taxes, for instance, after reaching 6.1% of GDP on average toward the end of the first decade of this century (roughly 35% of the total federal tax take), have ceased their relative rise, holding about steady at these relative levels. The White House’s plan calls for a very slight relative decline to 31.1% of total revenues (5.9% of GDP) by 2019.  Excise taxes have all but ceased to matter in the equation. They remain in the plan at about 3% of the total federal take (0.6% of GDP), more from levies on tobacco and alcohol than tariffs. Proposed corporate tax reforms, in which the code lowers statutory rates while shredding tax breaks, turn out in the president’s plan to raise revenues on balance. According to the budget document, corporate taxes will rise from 11.1% of the total tax take this year (1.9% of GDP) to 12.2% in 2019 (2.3% of GDP).     

Takeaway      
Except in the unlikely event that Washington forswears its ever-growing economic and financial demands, this revenues picture makes a powerful case for major tax reform. The country could benefit from a reduction in payroll taxes. To be sure, they have increased because of their natural link to social spending. But these high rates nonetheless discourage job creation among employers and discourage paid work generally among the population. They are regressive, too, falling relatively hardest on poorer workers, who never reach the point where some payroll taxes top out and in any case pay at the same rate as high-income earners. Since excise taxes can in no way take up the slack and corporate tax hikes would impair international competitiveness, the only place to make up the difference would seem to lie with personal income taxes. It would, however, be less than productive simply to expand the existing structure. The economically efficient way to absorb the burden would involve a broadening of the tax base, a lowering the statutory rate, and simultaneously ending many of the long list of tax deductions that mostly benefit higher-income people. It is encouraging that both sides of the aisle in Washington are considering such reforms, but discouraging that the present rancor in the capital precludes any progress, probably until after the next presidential election. 

 

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