Overview of U.S. Federal Taxeswith emphasis on the Personal

Income TaxPublic Econ Seminar, Econ 398

Joseph Guse

History of Federal Budgetsource: 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 2005Source: 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 HistorySource: www.whitehouse.gov/omb/budget/Historicals (Table 2.2)

History of Personal Income TaxSummarized 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 WealthWould 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

• 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!