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U.S. Budget Taxes and Income Primer

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Income Taxes

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How the Budget Is Funded:

The U.S. Government's total revenue is projected to be $2.902 trillion for Fiscal Year 2013. That's more than the FY 2012 revenue of $2.469 trillion, and the actual received income in FY 2011 of $2.303 trillion. Tax receipts are rising because the economy is improving.

All the Tax Burden Really Falls on You:

The individual taxpayer -- you -- provides most of the income for the Federal Government’s budget. That's because income taxes contribute 46.8%, or $1.359 trillion, toward total FY 2013 revenue receipts. Social Security, Medicare and other payroll taxes (still mostly you) add 33%, or $959 billion. Corporate taxes toss in $348 billion, or 12% toward the total. Excise and estate taxes contribute $101 billion, or 3.5%.

The Federal Reserve, as the bank for Federal government agencies, pays interest on the billions of dollars in operating funds deposited by various Federal agencies. This totals $80 billion, or 2.8%. The rest ($55 billion) comes from custom duties and other miscellaneous receipts. (Source: OMB Summary Tables, Table S-5)

The Congressional Budget Office (CBO) points out that, in effect, the entire U.S. tax burden really falls on individuals. That's because corporations pass on their tax burden to families in the form of higher prices or lower wages. Corporations must maintain their profit margin to satisfy stockholders, so any additional corporate taxes will be passed on to consumers or workers. Bottom line -- everything the government spends ultimately comes out of your pocket, no matter what happens with the corporate tax rate.

The Budget's Relation to Economic Growth:

The Office of Management and Budget (OMB) estimates revenues at 17.8% of GDP for FY 2013. Thanks to the recession, this is less than the normal 19% target. That's because of tax cuts from Obama's economic stimulus package, the extension of the Bush tax cuts through 2011, and the Obama tax cuts, which reduced payroll taxes and extensions to unemployment benefits.

Income taxes were lowered to spur the consumer spending that drives 70% of economic growth. Most people didn't even realize taxes were lowered, since the tax cut showed up as lower withholding instead of a check. However, this didn't stimulate economic growth as much as was hoped. Instead of spending all the extra cash, people used some of it to pay off debt. The recession scared people into saving more and using credit cards less.

Do Tax Cuts Boost Economic Growth?:

Supply-side economics is the theory that says tax cuts increase economic growth. A study by the Treasury Department showed that, in the short-term and in an economy that is already weak, tax cuts provided an immediate boost. The cuts must ultimately be balanced with a reduction in spending to avoid increasing the Federal debt.

Left unchecked, the Federal debt would eventually slow the economy. If the debt-to-GDP ratio is too high (near 90%), it's perceived as a tax increase on future generations, who ultimately must pay it off. (Source: U.S. Treasury Department, A Dynamic Analysis of Permanent Extension of President's Tax Relief, July 25, 2006)

However, extending unemployment benefits are the best way to boost economic growth. A study by Economy.com found that every dollar spent on unemployment benefits stimulates $1.73 in economic demand. Why? The unemployed wind up spending every dollar they receive on essentials like as food, clothing and housing. Although extended benefits cost taxpayers $10 billion every month, they generate $17.3 billion in economic growth, creating jobs and additional tax revenue.

Effect of the Bush Tax Cuts:

During the 2001 recession, the percentage of Federal revenue to GDP went up to 20.9% -- higher than the norm. That's because the economy shrank. To stimulate growth, the government cut taxes in 2001 (JGTRRA) and 2003 (EGTRRA). After the tax cuts of 2001, Federal revenue fell to 18% of GDP. The tax cuts of 2003 reduced the revenue percentage even further, to 16% of GDP in 2004. However, these tax cuts were initially a success. The economy recovered. Even though the percent of government revenue to GDP decreased, the total revenues increased because GDP increased.

Supply-side proponents said the growth in GDP was because of the tax cuts. Other economists pointed out that interest rates were also lowered during the same time period. The Federal Reserve lowered the all-important Fed funds rate from 6% to 1% between 2001 - 2003. (Source: New York Federal Reserve, Historical Fed Funds Rate)

The Tax Increase Prevention and Reconciliation Act of 2005 extended lower tax rates for long-term capital gains and dividends through 2010. This did not significantly impact government income, and the percentage to GDP returned to 18% by 2006.

Can Tax Cuts Increase Federal Budget Revenue?:

The Laffer Curve states that tax cuts reduce government revenue dollar-for-dollar, but recoup that loss over the long term by boosting economic growth, and the tax base. However, the National Bureau of Economic Research found that only 17% of the revenue from income tax cuts was regained, and 50% of the revenue lost from corporate tax cuts. One reason for this discrepancy could be the tax rate before tax were cut. According to Laffer's model, the tax rate must be in the "Prohibitive Range" -- above 50% -- for the cuts to stimulate the economy enough to recoup all the losses. (Source: NBER, Dynamic Scoring:A Back of the Envelope Guide, December 2004) Article updated February 20, 2012

History of Federal Budget Income Since 2006:

For Federal government income earlier in U.S. history, go to Budget Historicals.

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