Federal Government Taxes
Government expenditures are financed for the most part by government taxes. Below is a table that includes the most important United States federal government taxes and other receipts. The figures are in billions of United States dollars.
Individual income taxes and Social Security taxes are responsible for the majority of the federal government’s tax receipts. After the 2008 recession, revenues declined considerably, but mostly rose again several years later due to a growing economy and increases in the Social Security retirement age.
Federal tax revenue for 2022 was $4,437 billion. Spending for 2022 (see previous section) was $5,852 billion. This means that the United States federal government deficit (receipts minus expenditures) in 2022 was $1.415 billion. This amount is substantial and is expected to pose financial problems for future generations.
Social Security Taxes and the Future of Social Security
Social Security or FICA (Federal Insurance Contribution Act) taxes for an individual equal $7.65 of every $100 earned. The Social Security portion of this tax (6.2%) is subject to maximum earnings of $147,000 in 2022. The Medicare portion of the FICA tax is 1.45% and 2.35% for high income earners. There is no maximum earnings limit on Medicare. All income is subject to the Medicare tax. Employers are required to match these percentages, so that the federal government receives 15.3% of each paycheck (up to the maximum earnings amount for the Social Security component) and more from higher earning households.
The Social Security program has some accumulated savings (the Trust Fund), but most of the program is a pay-as-you-go program. This means that the majority of the tax collected this year pays for benefits of this year’s retirees. Because of the large number of Baby Boomers, who are currently retired or soon will be retired, the fund is insufficient to meet the demands in the future. To fix this problem, either the FICA tax needs to be raised, benefits need to be lowered, or the retirement age needs to be raised (this is already happening).
Due to the inefficiencies of the program and the lack of discipline on the part of the federal government to invest the money wisely, the idea of phasing in a privatized system has gained support. Privatization will allow each worker to invest all or a portion of the tax in her/his own retirement account. The government can still require this retirement contribution. However, each person will have full control over her/his allocation. Most likely, the rate of return on individuals’ investments will be higher than the Social Security rate of return. In addition, when an individual passes, her/his family and friends will receive the amount left in the estate. This is especially helpful for lower income individuals whose life expectancy is lower. Lower income individuals also start working earlier than higher income, higher educated individuals, so that in the current Social Security program lower income individuals contribute more years, but receive benefits fewer years. This increases our income/wealth inequality.
A privatization program may need to be phased in slowly. Concerns about this plan include the volatility of the stock and bond markets, transition costs to switch from a public to a private system, and the fear that some people are not knowledgeable enough to invest their own funds. To mitigate this, our middle and high schools could offer more thorough curricula in financial planning.
For more information about Social Security taxes and benefits, visit http://www.ssa.gov.
The United States Tax System
The United States individual income tax system is a progressive tax system. This means that households with higher incomes pay a higher percentage in tax. Because of the tax reform passed in December of 2017, the tax brackets for individuals and married couples have changed (see tables below).
For persons filing “single”, the marginal tax rates are as follows:
|Current (2023) Rate||Current Income Bracket||Old (2017) Rate||Old Income Bracket|
|10%||Up to $11,000||10%||Up to $9,525|
In the current system, an individual who earns, for example, $100,000 is in the 24% marginal tax bracket. This means that for every additional dollar earned over $100,000 (and up to $182,100) this person pays $.24 in federal income tax. Note that this person still only pays 10% over the first $11,000 earned; 12% of the amount in the next bracket, 22% of the amount in the next bracket, etc. Therefore the average tax paid for this person will be less than 24% (see video at the bottom of this page for a sample calculation).
For married couples filing jointly, the marginal tax rates are as follows:
|Current (2023) Rate||Current Income Bracket||Old (2017) Rate||Old Income Bracket|
|10%||Up to $22,000||10%||Up to $19,050|
Source: Internal Revenue Service (www.irs.gov)
For most tax payers the marginal tax rate is lower in the new tax system. In addition, there is a higher standard deduction ($13,850 for single filers and $27,700 for joint filers in 2023). However, there are fewer deductions for persons who itemize. For example, the limit on deducting state and local taxes is $10,000 (these include state and local income, sales, real estate, or property taxes). Mortgage interest deductions are limited to the interest on the first $750,000 of mortgage debt. In addition, interest on home equity loans will not be deductible (even those taken out before December 31, 2017). The marginal tax rate on long-term capital gains (earnings from selling stocks, bonds and other financial assets) continues to range from 0% to 20% (0, 15, or 20%, depending on your income). High-income tax payers pay an additional 3.8% net investment tax. Short-term (one year or shorter) capital gains are taxed at regular individual income tax rates.
Two frequently discussed tax systems that have been offered as alternatives to the current individual income system are the proportional or flat tax system, and the consumption tax system.
The Flat Tax System
Under a flat tax system, everyone pays the same percentage tax. For example, if the tax rate is 20%, then a household earning $300,000 will pay 20% ($60,000) and a household earning $30,000 will also pay 20% ($6,000). Note that even though the rate is the same, the dollar amount of taxes paid by the higher-income household is higher. Most flat tax systems allow for tax exemptions of the lower-income households. For example, the plan could stipulate that anyone earning up to $25,000 does not pay any tax. This in effect will mean that a household paying $30,000 will pay 0% up to $25,000 and then 20% of the remaining $5,000. The total tax for this household then equals $1,000.
Flat tax systems are considered very simple, because they do not allow households to use deductions in order to lower their taxable income. In the current progressive income tax system, households are allowed to deduct from their taxable income many expenses, including the interest on their mortgage, the interest on their home equity loans, certain medical expenses, certain professional expenses, charitable contributions, certain retirement contributions, and dependent care expenses.
A flat tax system will have a lower tax rate for most people, but will not allow deductions. For this reason, industries, such as the real estate industry and the private welfare industry, may not be happy with the flat tax system. Accountants, tax professionals and government tax auditors will also not be happy with a flat system, as the simplicity of the system makes many of their jobs unnecessary. Does this mean that unemployment will rise, as most of the accounting and tax preparation jobs will be eliminated? The answer is no. Just like throwing bricks through a window doesn’t increase overall employment, complicating the tax system doesn’t increase overall employment, either. Yes, a complicated tax system increases employment of accountants, tax professionals, and government tax auditors, as glaziers also will gain employment in an economy with many broken windows. However, the additional savings that households experience from not having to hire accountants, tax professionals, and not having to pay taxes to the government for the tax professionals will allow these households to increase their spending on other things. This is similar to the baker being able to buy a suit if his window is not broken (see Unit 1). Households may now be able to afford a hot tub in their backyard. This certainly sounds more fun than spending this amount of money to have your taxes prepared.
Another characteristic of the flat tax system is that the flat tax rate is lower than the highest marginal tax rate in the progressive system. This means that as your income increases, you will have more incentive to work harder and earn more income. This stimulates economic activity and creates jobs.
For a video explanation of the flat tax system, please watch:
The Consumption Tax System
Under a consumption tax system, everyone will pay taxes on the goods and services they buy, instead of paying individual income taxes.
For example, when someone buys a $30,000 car and the consumption tax is 20%, this person will pay $6,000 in taxes. This makes the price of the car effectively $36,000. This may seem like a big price hike. However, households do not pay any income taxes anymore, so households’ purchasing power stays approximately the same. In other words, the real price of goods and services will remain the same, as households’ after-tax incomes have increased proportionately.
Another advantage of the consumption tax is that it is more difficult to avoid taxes. Everyone that buys non-essential and legitimate (legal) products will pay taxes. This includes people who earn their money in the underground economy (drug dealers, prostitutes, and other workers not reporting their incomes). Most consumption tax plans allow for exemptions on certain products, such as essential foods, housing, and medical care. This means that lower-income households that spend the majority of their income on these items will, in effect, pay little or no tax. The advantage of a consumption tax system replacing an income tax system is that no one will have to complete an individual income tax return, because there is no individual income tax anymore. Taxes will be collected by businesses who submit the consumption tax to the federal government, just like they are submitting excise taxes to the federal and state governments and sales taxes to most state governments.
For a video explanation of the consumption tax system, please watch:
The Burden of Tax
The table below shows the percentage of total federal tax dollars and total individual income tax dollars paid by the various income groups, categorized by the amount of their earnings. For example, the top 10% includes those households earning more than $138,031, and the bottom 50% are the households earning less than $39,275 per year. The top 10% of all income earners paid more than 70% of all federal individual income taxes. The bottom 50% paid less than 3%.
|Income Group||Households Approximate Annually Earning:||Approximate Percentage Share of All Gross Income Earned||Approximate Percentage of Federal Individual Income Tax Paid|
Source: National Taxpayers Union (http://www.ntu.org/foundation/page/who-pays-income-taxes), (latest available data)
For a video explanation of a calculation of total tax amount paid and the average tax rate, please visit:
Individual Income Tax System Top Rates
Individual income tax rates in the United States have fluctuated significantly over the years. Tax rates in other industrialized countries have undergone similar changes. Below is a brief historical account of the main changes in the United States.
|In 1913, the beginning of the current income tax system in the United States, the individual tax rate was 1% on taxable income of $4,000 for married couples. The rate was 7% on incomes above $500,000.|
|During the first World War, the highest marginal rate was 77%. It came down to 25% following the war.|
|Income tax rates rose during the Great Depression. The top rate increased to 75% in 1939, and reached 91% during World War II.|
|In 1964, the top rate decreased to 70%.|
|In 1981, the top rate decreased to 50%.|
|In 1986, the top rate decreased to 28%. The bottom rate increased from 11% to 15%, and the system was simplified to two brackets (15 and 28%).|
|During the 1990s, the top rate rose to 39.6%.|
|In 2001, the top rate decreased to 35% and the bottom rate decreased to 10%.|
|In 2013, the top rate increased to 39.6%.|
|In December, 2017, the top rate was lowered to 37%.|
The Effect of a Tax Cut on the Rich and the Poor
Tax cuts are often controversial because of the effects they have on the different income groups in our society. The following story is an analogy about our tax system.
|An Across the Board Tax Cut – Why it Favors the Rich More
Sometimes politicians can exclaim; “It’s just a tax cut for the rich!”, and it is just accepted to be fact. But what does that really mean?
The first four persons (the poorest) would pay nothing.
The ten persons ate dinner in the restaurant every day, and seemed quite happy with the arrangement, until one day, the owner threw them a curve. “Since you are all such good customers,” he said, “I’m going to reduce the cost of your daily meal by $20.” So, now dinner for the ten only cost $80. The group still wanted to pay their bill the way we pay our taxes. So, the first four persons were unaffected. They would still eat for free. But what about the other six, the paying customers? How could they divvy up the $20 windfall so that everyone would get his ‘fair share’?
The six persons realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth person and the sixth person would each end up being ‘PAID’ to eat their meal. So, the restaurant owner suggested that it would be fair to reduce each person’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay. And so:
Each of the six was better off than before. And the first four continued to eat for free. But once outside the restaurant, they began to compare their savings. “I only got a dollar out of the $20,” declared the sixth person. He pointed to the tenth person “but he got $10!” “Yeah, that’s right,” exclaimed the fifth. “I only saved a dollar, too. It’s unfair that he got ten times more than me!” “That’s true!!” shouted the seventh person. “Why should he get $10 back when I got only $2? The wealthy get all the breaks!” “Wait a minute,” yelled the first four in unison. “We didn’t get anything at all. The system exploits the poor!”
The nine surrounded the tenth and beat him up. The next night, the tenth man didn’t show up for dinner, so the nine sat down and ate without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!
And that is how our tax system works.
Source: author unknown
The Laffer Curve and the Effect of a Tax Cut on Government Revenue
Another tax issue that surfaces from time to time is the effect of a tax cut on government tax revenue. One may expect that if the government cuts taxes, then government tax revenue decreases. However, economist Arthur Laffer predicts that at certain tax rates, government tax revenue increases when the government implements a tax cut, and vice versa. Laffer predicts this because he believes that if tax rates are high and tax rates decrease, people have more incentive to work, and the increase in the work more-than-compensates for the decrease in the tax rate. The now famous “Laffer Curve” (see below) illustrates this phenomenon.
In the graph, this hypothetical country’s government receives no revenue at a tax rate of 0%, because no taxes are paid. Also, at a tax rate of 100%, the government receives no revenue, because there is no incentive to work. At a tax rate of 30%, the tax revenue reaches a maximum level of $600 billion. If the country’s current rate is 75% (the revenue is $400 billion at this tax rate), the government will experience an increase in tax revenue of $200 billion, if it were to cut the tax rate to 30%. Similarly, the government will experience an increase in tax revenue if it were to cut the rate, if the current rate is at any level above 30%.
For a video explanation of the Laffer Curve, please visit: