Overview of U.S. Federal Taxes
with emphasis on the Personal
Income Tax
Public Econ Seminar, Econ 398
Joseph Guse
History of Federal Budget
source: www.whitehouse.gov/omb/budget/Historicals (Table 1.2)
Most Common Types of Taxes
• Individual Income Taxes. Progressive structure. Levied
on all income – labor and capital.
• Payroll Taxes. Finance SS, Unemp Ins, Medicare. Levied
only on labor income. Regressive structure.
• Corporate Income Taxes.
• Wealth Taxes. Federal Estate Tax and Gift Taxes. Local
Property Taxes.
• Consumption Taxes. Federal excise taxes (e.g. gas and
cigs) and import tarriffs. Local sales and excise taxes.
• Other Revenue Sources.
Revenue and Shares by Type Federal Tax 2005
Source: BEA via Slemrod and Bakija
Receipts
($Billions)
Share of Federal
Revenue
Share of GDP
Personal Inc. Tax
928
41.3%
(7.4%)
Payroll Taxes (Soc Ins)
855
38.1%
(6.9%)
Corporate Inc.Tax
326
14.5%
(2.6%)
Excise Tax,Customs
101
4.5%
(.8%)
Estate and Gift Tax
25
1.1%
(.2%)
Total
2247
100%
(18%)
Total State and Local
1185
(9.5%)
Revenue Composition History
Source: www.whitehouse.gov/omb/budget/Historicals (Table 2.2)
History of Personal Income Tax
Summarized from Bakija and Slemrod
• Civil War Era Income Tax 1861-1871.
• 1894. Income Tax Enacted but Overruled by Supreme
Court.
• 1913. 16th Amendment. Start of modern Income Tax.
• 1914. Graduated Rates (1-7%). Large Personal Exemption:
only 0.5% of population has income high enough to have
any liability. Still only 6% on eve of WWII.
• 1917 Deductions for mortgage interest, local taxes and
charitable giving already in place.
• WWII. Receipts goes from 1 to 8% of GDP. Percent filing
goes from 6% to 34% of population. Employer withholding
introduced.
Top Marginal Rate History
Source: www.taxpolicycenter.org/taxfacts
Definition of “Income”
• Haig-Simon: “The increase in person’s ability to consume over a
given period of time”
Income = Consumption + Net Change in Wealth
Would include…
• Wages
• Value of all Employer and Govt benefits
• Capital Income (rent, dividends)
• Capital Gains/Losses (whether realized or not) in real terms.
(appreciate and depreciation).
• Domestic production
• Value of services from owned durable good. (Rental value of own
home, cars, etc)
• Subtract cost of earnings (inputs, interest, maintenance costs, etc)
Further Discussion of Haig-Simon definition
• Problem with measurement.
– Timing problems. Lotteries and annuities.
Retained corporate earnings.
– Uncertainty Problems. E.g. Intellectual property.
• Why we care
– Taxing only some forms of income lead to
distortions and fairness issues.
Federal Tax Definition of Income
• Tax code “lays out transactions and events
that trigger tax liability”
• Adjusted Gross Income (AGI)
– Wages and Salaries (73%)
– Returns to Capital (dividends, interest, cap gains,
rent, royalties)
– Small Business Income (mixture of the two)
Capital Issues
• MOST Interest and Dividend Income is exempt (pension plans, tax-free
bonds, etc), though some dividend income excluded from AGI may have
taxed by corporate income tax.
• Only Realized Nominal Gains/Losses counted
• Exemptions
– Gains held until death
– Gains on owner-occupied housing up to $500K
• Cap gains are taxed at special rates (15%)
• In general cap gains can be taxed once, twice (because of interaction with
Corporate Tax) or not at all!
– The amount of cap gain included in AGI over 1980 – 2004 is roughly equal to
Haig-Simon definition, but that just reflects rough balance of huge “errors” in
both directions.
• Interpretation: Because of generally lower rates on returns to savings (via
exemptions from 401ks, IRAs, and special cap gains rate), our system is
really a hybrid of an income tax and a consumption tax.
Other Exclusions from Taxable Income
• $1 trillion (2004) excluded from AGI due to
evasion.
• $363B (2004) State and Local Tax Deduction
• $340B (2004) Mortgage/Home Equity Loan
Interest Deduction.
• $166 (2004) Charitable Contributions
• $62 (2004) Medical Dental Deductions
• Standard Deduction
• Personal Exemptions
2012 Marginal Rates (Single)
Source: IRS
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•
•
•
•
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10% on taxable income $0 to $8,700, plus
15% on taxable income $8,700 to $35,350
25% on taxable income $35,350 to $85,650
28% on taxable income $85,650 to $178,650
33% on taxable income $178,650 to $388,350
35% on taxable income $388,350.
Marginal Rates, 2012, Married Jointly
•
•
•
•
•
•
10% on taxable income $0 to $17,400
15% on taxable income $17,400 to $70,700
25% on taxable income $70,700 to $142,700
28% on taxable income $142,700 to $217,450
33% on taxable income $217,450 to $388,350
35% on taxable income $388,350.
Tax Credits – Welfare Through the Tax Code
• EITC and Child Credit are Refundable
• EITC is a wage subsidy that eventually get
phased out as income increases. Ramp-up,
plateau, phase-out structure.
– 2007 example. Married with 2 children. 40% up
to $11,790. plateau to $17,390. phase out at 21%
rate. EITC is zero above $39,783.
• Child Credits. $1000 per kid!