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Last week’s Congressional Budget Office fiscal update largely focused on the dangers of rising spending on health care, Social Security, and interest on the debt. But it also projected a significant increase in federal revenues, almost entirely due to a big bump in individual income taxes. CBO projects that individual tax revenue will climb well above its long-term average over the next decade.
Overall, federal revenues will rise as a share of Gross Domestic Product, but not fast enough to offset increased spending. The boost in revenues would continue a trend that began with the economic recovery. Tax revenue plunged during the Great Recession, due to lower income and corporate profits as well as the mostly temporary tax cuts in the American Recovery and Reinvestment Tax Act of 2009 (ARRA) and the mostly permanent tax changes of its successors.
Individual income taxes fell furthest, bottoming out nearly 2 percentage points below their 1974-2013 average of 7.9 percent of GDP (see figure). Corporate income taxes plummeted from 2.6 percent of GDP in 2007—more than a third above their long-run average—to just 1 percent of GDP in 2009. And social insurance taxes that support Social Security and Medicare declined by 0.8 percent of GDP, because of falling wages and the 2011-2012 payroll tax holiday that cut the worker’s share of Social Security tax from 6.2 percent to 4.2 percent. Revenue from other sources had been drifting downward for nearly a decade before the recession but only a little.
All four sources of revenue have recovered since 2009 and CBO projects that each will be close to its 40-year average this year. But the pattern changes over the next decade.
According to CBO, social insurance taxes will fall to 5.8 percent of GDP, slightly below their 6 percent long-run average. Corporate income taxes will climb for a few years before drifting back to their norm. Other non-income tax revenue will fall slightly, also to a little below its average.
But in sharp contrast, individual income taxes will climb steadily throughout the decade, says CBO, because real income will rise and because retirees will withdraw larger amounts from their tax-deferred retirement accounts. In 2024, individual income taxes will claim 9.4 percent of GDP, fully 1.5 percentage points above the historical norm. As a result, total revenues will rise to 18.2 percent of GDP, nearly a percentage point above average.
But even with higher revenue, the deficit will average just over 3 percent of GDP, almost exactly its 40-year average. After dipping to 2.6 percent of GDP in 2015, says CBO, the deficit will climb to more than 3.5 percent in 2022 and beyond, largely due to increasing spending for health care and interest on the debt.
CBO’s projections—as always—assume that current tax law will not change. Specifically, that means Congress will not renew the more than 50 tax breaks that expired this year and will not extend provisions scheduled to expire over the decade. Renewing the preferences that have already lapsed would cut revenues by roughly $1 trillion over the next decade, about 2.5 percent of expected total revenue. That’s not a small hit.
The growing income tax collections that CBO projects over the next decade won’t fill the gap between spending and revenue, even if Congress lets popular tax cuts expire. We need to find ways to collect more revenue if we’re going to keep federal deficits in check.
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