CHAPTER
5
The Long-Term Outlook for Revenues
The federal government collects revenues in the form of individual and corporate income taxes, social insurance (payroll) taxes, excise taxes, estate and gift taxes, customs duties, and miscellaneous receipts. Policymakers adjust the level and composition of revenues frequently and will probably make significant changes to the tax system over the next 75 years.
Many potential paths exist for future revenues. Moreover, the total revenues assumed under any particular scenario could be generated from a variety of policies that would have very different implications for the economy and for the share of income paid in taxes by people at various income levels. This analysis focuses on two potential scenarios for federal receipts. The extended-baseline scenario assumes that current law remains in place: The tax cuts enacted in 2001 and 2003 and those in the recent stimulus bill expire as scheduled, and the individual alternative minimum tax remains the same. Under that scenario, estimated revenues for the next 10 years would be consistent with the Congressional Budget Office’s March 2009 baseline projections, which also include the effects of the economic recovery expected over the next few years. After 2019, revenues would rise relative to GDP. Over the 2009–2035 period, they would rise from almost 16 percent of GDP in 2009 to almost 22 percent in 2035, an increase of roughly 6 percentage points (see Figure 5-1).
Total Federal Revenues Under CBO’s Long-Term Budget Scenarios
(Percentage of gross domestic product)
Source: Congressional Budget Office.
Note: The extended-baseline scenario adheres closely to current law, following CBO’s 10-year baseline budget projections from 2009 to 2019 and then extending the baseline concept for the rest of the projection period. The alternative fiscal scenario deviates from CBO’s baseline projections, beginning in 2010, by incorporating some changes in policy that are widely expected to occur and that policymakers have regularly made in the past.
The alternative fiscal scenario, by contrast, starts with tax law for the individual income tax as it stands in 2009 and generally assumes that it remains unaltered over the projection period. Thus, not all of the expirations or other changes to tax law scheduled to occur in coming years are assumed to take effect. The alternative fiscal scenario also assumes that the parameters of the AMT will be indexed for inflation after 2009. Under this scenario, revenues as a share of GDP would increase to a smaller extent than under the extended-baseline scenario: by roughly 3.4 percentage points between now and 2035.
Over the long term, the cumulative effects of inflation and real (inflation-adjusted) growth in income interact with the tax system in both scenarios. The result is higher average tax rates—that is, taxes as a share of income—and a significant change in the distribution of taxes. Under the extended-baseline scenario, the cumulative effects of inflation would cause nearly half of all households to be subject to the AMT by 2035 and almost three-quarters of all households by 2080; at that point, revenues would reach 26 percent of GDP. The impact of inflation and real income growth would be smaller under the alternative fiscal scenario.
Revenues Over the Past 50 Years
In the past half-century, total revenues have ranged from 16.2 percent to 20.9 percent of GDP (averaging 18.1 percent), with no obvious trend over time (see Figure 5-2). During that period, however, the various sources of revenue have changed in importance. Individual income taxes, which account for about half of all revenues, have varied between 7 percent and 10 percent of GDP. Social insurance taxes, which make up about one-third of total revenues, have grown from 2 percent to about 6.5 percent of GDP. (Those taxes consist primarily of payroll taxes credited to the Social Security and Medicare Hospital Insurance Trust Funds.) Corporate income taxes contribute less now than in earlier years: in 2008, about 12 percent of overall revenues, or about 2 percent of GDP, down from nearly 6 percent of GDP a half-century ago. Revenues from other taxes and duties, as well as miscellaneous receipts, make up the balance—accounting for roughly 1 percent to 3 percent of GDP over the past 50 years.
Revenues, by Source, Fiscal Years 1953 to 2008
(Percentage of gross domestic product)
Source: Congressional Budget Office.
Some of the variation in the composition of total tax revenues has stemmed from the interaction between the tax code and changes in the economy. For example, excise tax receipts have tended to decline over time as a percentage of GDP because many are specific levies (such as cents per gallon of gasoline) that are not indexed for inflation. Therefore, they have diminished in importance as the general level of prices has risen. In contrast, income tax receipts have tended to grow relative to GDP because increases in prices have caused various thresholds in the income tax system to decline in real terms, thus boosting the amount of income subject to taxation at higher rates.
More of the variation in tax revenues from different sources has resulted from legislative changes, as policymakers adjusted tax rates and other parameters of the tax system—sometimes to offset the impact of economic changes on taxes. For instance, much of the individual income tax system was indexed over time to prevent inflation from raising income taxes relative to GDP. Even so, real growth results in higher average tax rates under current law because a greater share of income is taxed in higher tax brackets (a circumstance commonly known as real bracket creep). Without future adjustments, a host of characteristics of the current tax system will continue to interact with economic trends and cause receipts, on net, to grow faster than GDP.
Factors Affecting Future Federal Revenues
In the absence of legislative action, the individual income tax system has the greatest potential to increase the ratio of revenues to GDP because of the various ways in which its structure interacts with the economy.
First, the individual income tax system is progressive, meaning that households with higher incomes are taxed at higher rates. Consequently, as GDP and hence individual incomes grow, an ever-larger proportion of income will be subject to higher tax rates, both because the amount of income taxed at the highest rates will increase and because the amount of earned income tax credits claimed by low-income taxpayers will decline. Much of the tax system is indexed for inflation, so those changes will result primarily from growth of real GDP. But some features of the regular income tax system are not indexed, so inflation will cause additional, though modest, increases in receipts relative to GDP over the projection period.
Second, the individual income tax system includes the alternative minimum tax, which subjects more taxpayers and a greater fraction of income to higher tax rates as incomes grow. The AMT is a parallel income tax system with fewer exemptions, deductions, and rates than the regular income tax. Households must calculate the amount they owe under both the AMT and the regular income tax and pay the higher of the two amounts.1 The AMT is not indexed for inflation. Therefore, as sustained inflation increases nominal incomes over time, it causes more taxpayers to pay the AMT and causes the AMT to claim an ever-larger share of GDP.
Third, current tax law includes an increase in revenues in 2011. Most of the provisions in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) are scheduled to expire after December 31, 2010, as are most of the tax provisions in the American Recovery and Reinvestment Act of 2009 (ARRA). When that happens, the tax code will revert to prior law: Tax rates will rise, some tax credits will fall, and thresholds for certain rates will shift. Those changes will increase the level of receipts as a share of GDP in 2011 and beyond.
Fourth, between now and about 2030, the Treasury will receive some tax revenues that have essentially been deferred. Contributions to retirement plans—such as 401(k) plans and individual retirement accounts—and to employer-sponsored defined-benefit plans are tax-exempt when they are made. The income earned on assets in those accounts is also exempt from taxes, but withdrawals from those plans are taxable. As the baby boomers retire and withdraw money from their accounts, those sums will make up a rising portion of taxable income, which will tend to boost tax receipts relative to GDP.
At least one factor, however, will reduce tax receipts over time. The share of employees’ compensation that is paid in the form of wages and salaries (which are subject to income and payroll taxes) will decline, CBO projects, because of rising spending on nontaxable fringe benefits such as employer-paid health insurance. That declining share will decrease taxable income—and thus revenues from both income and payroll taxes—relative to GDP.
The design of two smaller revenue sources—excise taxes and estate taxes—will also contribute to altering revenues as a share of GDP over time. Most excise tax receipts stem from duties that are levied as a fixed charge per unit purchased. Under current law, the fee schedule for most excise taxes is projected to stay the same. As a result, excise taxes will not grow as fast as the economy and thus will decline relative to GDP over time. In the other direction, the dollar amount of an estate that is exempt from taxation will remain fixed after 2011 under current law. Consequently, a greater share of wealth will be subject to the estate tax over time. With the tax base growing relative to GDP under current law, estate tax receipts will rise relative to GDP over the long term. That projected increase in estate tax receipts will more than offset the decrease in excise tax revenues as a percentage of GDP.
Both payroll and corporate taxes are projected to remain relatively constant as a share of their tax bases—wages and corporate profits, respectively—during the next 75 years. Most corporate profits are taxed at the top corporate rate, so real bracket creep does not lead to a higher average tax rate over time. CBO’s long-term scenarios assume that profits will grow at the same rate as GDP over the long run, and thus corporate tax receipts are projected to remain constant as a share of GDP.
Payroll taxes are levied as a fixed percentage of wages, with one portion of the tax applying only up to a specified taxable maximum amount. Because that taxable amount is indexed for wage growth, the average payroll tax rate on wages is expected to remain relatively constant over the long term. The only significant change in the ratio of payroll taxes to GDP through 2080, therefore, comes from the aforementioned impact of rising spending for nontaxable fringe benefits on the size of wages as a share of GDP.
Revenue Projections Under CBO’s Long-Term Budget Scenarios
CBO’s long-term budget scenarios consider two possible paths for revenues. The first would extend the agency’s current 10-year baseline projections for revenues. Like the baseline, that scenario assumes that current law remains in place, particularly with regard to the following:
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The provisions of EGTRRA, JGTRRA, and ARRA expire as scheduled, |
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No changes are made in tax law to slow the automatic increase in tax revenues that results from the interaction between economic growth and the progressive structure of the income tax. |
As explained above, although there is some tendency for rising health care costs to reduce revenues as a percentage of GDP over the long term, the dominant effect of the tax system’s current-law features is to increase receipts relative to GDP. Consequently, under the extended-baseline scenario, revenues would rise from nearly 16 percent of GDP in 2009 to almost 22 percent by 2035 and to 26 percent by 2080.
The second path, the alternative fiscal scenario, assumes that certain features of 2009 tax law are maintained for the individual income tax over the next 75 years:
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The provisions of EGTRRA and JGTRRA are assumed to be extended (though the tax provisions of ARRA are assumed to expire as scheduled), |
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The parameters of the tax code that are indexed for inflation are assumed to increase with inflation (as in the extended-baseline scenario), and |
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Unindexed parameters are assumed to remain at their 2009 values (again, as in the extended-baseline scenario), with the exception of the AMT, which is assumed to be indexed for inflation beginning in 2009. |
Under the alternative fiscal scenario, payroll tax receipts would be the same as under the extended-baseline scenario. Other sources of revenue (except the corporate income tax) are assumed to maintain the same ratio to GDP as in 2009. Corporate income taxes, however, would follow the path projected in CBO’s 10-year baseline, which assumes that corporate profits vary relative to GDP. After 2019, corporate tax receipts would be held constant as a percentage of GDP, because corporate profits are assumed to grow at the same rate as GDP for the rest of the 75-year projection period. In all, federal revenues would reach 19 percent of GDP by 2035 under the alternative fiscal scenario and nearly 22 percent by 2080. (For CBO’s assumptions about particular revenue sources under the two scenarios, see Table 5-1.)
Assumptions About Particular Revenue Sources Underlying CBO’s Long-Term Budget Scenarios
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Tax provisions in EGTRRA and JGTRRA are extended and AMT parameters are indexed for inflation after 2009 |
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As scheduled under current law through 2019; remaining constant as a share of GDP thereafter |
As scheduled under current law through 2019; remaining constant as a share of GDP thereafter |
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Source: Congressional Budget Office.
Notes: The extended-baseline scenario adheres closely to current law, following CBO’s 10-year baseline budget projections from 2009 to 2019 and then extending the baseline concept for the rest of the projection period. The alternative fiscal scenario deviates from CBO’s baseline projections, beginning in 2010, by incorporating some changes in policy that are widely expected to occur and that policymakers have regularly made in the past.
EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; JGTRRA = Jobs and Growth Tax Relief Reconciliation Act of 2003; AMT = alternative minimum tax; GDP = gross domestic product.
Under both of the long-term budget scenarios, individual income taxes would be responsible for most of the increase in revenues relative to GDP. By 2035, individual income tax receipts would rise by about 5.9 percentage points under the extended-baseline scenario and by about 3.4 percentage points under the alternative fiscal scenario. That difference of 2.5 percentage points between the scenarios largely represents the impact of two factors incorporated in the extended-baseline scenario: the mounting effects of the AMT and the expiration of provisions in EGTRRA and JGTRRA, both of which are currently the subject of much legislative interest.2 The difference in individual income tax receipts relative to GDP between the two scenarios would continue to grow over time, amounting to 3.6 percentage points by 2080.
The Impact of the AMT and Expiring Tax Provisions. The effects of those two major factors can be distinguished by comparing CBO’s long-term budget scenarios with a third scenario (a variant of the extended-baseline scenario), which assumes that policymakers do not index the AMT for inflation but that they permanently extend the tax provisions of EGTRRA and JGTRRA. Comparing that scenario with the alternative fiscal scenario, which assumes that the AMT is indexed for inflation, measures the growing impact of the unindexed AMT over time. Under the variant scenario, individual income tax revenues would be 0.8 percentage points higher in 2019 than under the alternative fiscal scenario (see Figure 5-3).3 That gap relative to GDP would widen to 1.9 percentage points by 2035 as the cumulative effects of inflation caused more taxpayers to be subject to the AMT.
Individual Income Tax Revenues Under Alternative Scenarios
(Percentage of gross domestic product)
Source: Congressional Budget Office.
Note: The extended-baseline scenario adheres closely to current law, following CBO’s 10-year baseline budget projections from 2009 to 2019 and then extending the baseline concept for the rest of the projection period. The variant of the extended-baseline scenario assumes that the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) do not expire as scheduled at the end of 2010. The alternative fiscal scenario deviates from CBO’s baseline projections, beginning in 2010, by incorporating some changes in policy that are widely expected to occur and that policymakers have regularly made in the past.
Likewise, comparing the variant scenario with the original extended-baseline scenario highlights the impact of the assumptions about EGTRRA and JGTRRA. The expiration of those two laws’ tax provisions would add about 0.8 percentage points to individual income tax receipts as a share of GDP in 2011. Thereafter, the annual addition would be smaller, amounting to about 0.6 percentage points in 2035 and remaining at that level, on average, through the 75-year projection period. The revenue impact of letting EGTRRA and JGTRRA expire would wane over time because of the growth of the AMT. As a greater share of individual income taxes was paid through the AMT, the effect of the two laws’ expiration would decline because many of the provisions of those laws do not benefit taxpayers who are subject to the AMT. Thus, the nonindexation of the AMT has a larger effect on long-run individual income tax revenues than does the expiration of EGTRRA and JGTRRA.
Other Factors Affecting Individual Income Tax Receipts. Even if the AMT was indexed for inflation and the tax provisions of EGTRRA and JGTRRA were made permanent—as in the alternative fiscal scenario—individual income tax revenues would continue to rise as a percentage of GDP. The main reason is the progressive rate structure of the tax system. As income grows, more income is taxed at higher rates. That factor would increase income tax revenues relative to GDP by 3.4 percentage points by 2035 and by 6.3 percentage points by 2080. Most of the increase stems from real bracket creep. But because even a low annual rate of inflation would amount to a significant rise in prices by 2080, some of the increase in receipts relative to GDP under the alternative fiscal scenario is attributable to the interaction between income growth and the remaining unindexed provisions of the tax code. If policymakers indexed all parameters in the tax code (including the AMT) for both real and inflationary growth in income, the parameters that tend to push up revenues relative to GDP would no longer do so.
Another factor that will contribute to the increase in income tax revenues as a share of GDP over the next few decades is the retirement of the baby-boom generation. Taxable withdrawals from retirement plans will rise as a percentage of GDP as the portion of the population receiving pension benefits grows through 2030 and levels off thereafter. As a result, for example, projected revenues as a share of GDP would climb by about 0.6 percentage points between 2009 and 2030 under the extended-baseline scenario. After 2030, the net impact of retirement contributions, earnings, and withdrawals would do little to change revenues as a share of GDP.
The factors that tend to boost receipts from individual income taxes as a share of GDP will be partly offset by the continuing rise in health care costs. For this analysis, CBO projects that health care spending excluding that for Medicare and the federal portion of Medicaid will increase from about 12 percent of GDP now to about 29 percent in 2080. That increase would shrink individual income tax revenues in two ways. First, rising health insurance premiums, which are generally tax-exempt, would reduce the portion of compensation that employees receive as taxable wages. Second, deductions related to medical expenses would increase relative to income as health care costs rose, thereby reducing taxable income. (Those deductions include the ones for medical expenses and for health insurance premiums paid by self-employed people.)
The revenue impact of rising health care costs can be estimated by comparing individual income tax revenues under the extended-baseline scenario with what revenues would be if health care costs grew at the same rate as GDP (see Figure 5-4). Faster cost growth for health care spending is projected to reduce individual income tax receipts as a share of GDP by 0.7 percentage points by 2035. The lower taxable wages that would result from such cost growth would also affect the payroll tax base, reducing projected payroll tax revenues by 0.2 percentage points by 2035. Rising health care costs would slow the growth of revenues under the alternative fiscal scenario as well. (By reducing taxable wages, however, the growth of health care costs would eventually reduce Social Security benefits, offsetting some of the negative budgetary effects of lower payroll tax revenues.)
The Impact of Rising Health Care Costs on Individual Income and Payroll Tax Revenues Under CBO’s Extended-Baseline Scenario
(Percentage of gross domestic product)
Source: Congressional Budget Office.
Note: The extended-baseline scenario adheres closely to current law, following CBO’s 10-year baseline budget projections from 2009 to 2019 and then extending the baseline concept for the rest of the projection period. Under that scenario, private-sector health care costs are assumed to grow faster than GDP, rising from about 12 percent in 2009 to 29 percent in 2080.
Under both of CBO’s long-term scenarios, revenues from payroll taxes are projected to decline slightly: from about 6.0 percent of GDP this year to 5.6 percent by 2080 (see Figure 5-5). Rising health care costs account for all of the decline. Without that factor, payroll taxes would be expected to remain roughly constant as a share of GDP. The important parameter for payroll taxes—the maximum earnings that are taxable for the Old-Age, Survivors, and Disability Insurance (OASDI) portion of Social Security—is effectively indexed for both real and inflationary growth (unlike the income tax) because the parameter is tied to average wages.4
Revenues, by Source, Under CBO’s Long-Term Budget Scenarios
(Percentage of gross domestic product)
Source: Congressional Budget Office.
Note: The extended-baseline scenario adheres closely to current law, following CBO’s 10-year baseline budget projections from 2009 to 2019 and then extending the baseline concept for the rest of the projection period. The alternative fiscal scenario deviates from CBO’s baseline projections, beginning in 2010, by incorporating some changes in policy that are widely expected to occur and that policymakers have regularly made in the past.
As a whole, other revenues (excluding receipts from individual income taxes and payroll taxes) follow similar paths under the two scenarios. Under the extended-baseline scenario, other revenues as a share of GDP would rise by 0.3 percentage points between 2009 and 2019 and then would stay about the same through 2035. Most of the rise over the next 10 years is attributable to higher revenues from estate and gift taxes and corporate taxes as a percentage of GDP. Scheduled changes to tax law cause the dollar amount of wealth exempt from the estate tax to fall in 2011. Because that exemption amount is not indexed for inflation or real growth thereafter, a greater share of wealth would be subject to the tax over time. The rise in corporate tax revenues over the next 10 years reflects a projected rebound from historically low levels in 2009 as the economy recovers from the recession. Other revenues are projected to remain fairly constant as a share of GDP from 2019 to 2035 because projected trends in excise taxes and estate and gift taxes roughly offset each other. (Corporate and other miscellaneous revenues are assumed to be constant as a percentage of GDP over that period.) Excise taxes as a share of GDP are expected to decline by between 0.1 and 0.2 percentage points between 2019 and 2035 because most excise taxes are specific levies and thus diminish in importance as prices increase. That decline in excise taxes as a share of GDP would be offset by an expected increase in estate and gift tax revenues.
Under the alternative fiscal scenario, most other revenues are assumed to hold steady as a percentage of GDP between 2009 and 2035. An exception is corporate income taxes, whose base (corporate profits) is expected to increase as a share of GDP under CBO’s 10-year baseline and then remain constant relative to GDP thereafter. By 2035, other revenues relative to GDP under this scenario are projected to be 0.1 percentage point below those under the extended-baseline scenario.
Implications of the Long-Term Revenue Scenarios
In both revenue paths, inflation and income growth would interact with tax parameters to change the characteristics of the tax system over time. Under the extended-baseline scenario, in particular, the tax system 75 years from now would be very different from the tax system today—many more taxpayers would pay the AMT, marginal and average tax rates would be higher, and the dollar value of some tax parameters would fall sharply in real terms and even more sharply relative to income. As a result of all of those changes, people at various places in the income distribution would pay a very different percentage of their income in taxes than they do now. Changes to the tax system from the expiration of the EGTRRA and JGTRRA provisions would be less significant than many of the changes that would result from the cumulative effect of growth in price levels and incomes over many years. Under the alternative fiscal scenario, the tax system would also change significantly over the next 75 years, even though that scenario does not include the changes associated with the expiration of EGTRRA and JGTRRA and mitigates much of the growing impact of the AMT by indexing its parameters for inflation.
The alternative minimum tax would have an especially significant impact on taxpayers under the extended-baseline scenario. By 2035, roughly 10 percent of individual income tax liability (the total amount owed) would be generated by the AMT, compared with about 3 percent today (see Figure 5-6). However, because tax liability under the AMT is calculated as the excess amount over the regular tax owed, the AMT’s contribution to receipts gives little indication of the number of people affected by the tax. Roughly 45 percent of the nation’s households would be subject to the AMT by 2035—a dramatic increase from the current figure of 3 percent.
The Impact of the Alternative Minimum Tax Under CBO’s Extended-Baseline Scenario
Source: Congressional Budget Office.
Note: The extended-baseline scenario adheres closely to current law, following CBO’s 10-year baseline budget projections from 2009 to 2019 and then extending the baseline concept for the rest of the projection period.
The share of households subject to the AMT would continue to rise under the extended-baseline scenario, reaching more than 70 percent by 2080. The AMT’s share of revenues would likewise continue to grow beyond 2035, peaking at about 15 percent of individual income tax liability around 2060. At that point, AMT revenue growth would level off as real bracket creep caused a greater share of income to be subject to the top marginal rate under the regular income tax. Not as much bracket creep would occur under the AMT. Therefore, the amount of additional tax liability under the AMT would decline as the amount of tax calculated under the regular tax rose. The AMT would continue to apply to many taxpayers, but the additional revenue attributable to it would diminish.
Under the alternative fiscal scenario, the indexing of the AMT’s parameters would mitigate most of the additional revenue growth generated by the tax under the extended-baseline scenario. The share of individual income tax receipts produced by the AMT would hold steady at roughly 3 percent through 2080. The fraction of households subject to the AMT would rise from about 3 percent to about 13 percent by 2080 under this scenario, but many of those households would not pay much in the way of additional tax.
Marginal Tax Rates on Income from Labor and Capital
Both long-term scenarios would see a rise in marginal tax rates on income from labor and capital. The increase in the marginal tax rate on labor would reduce people’s incentive to work, and the increase in the marginal tax rate on capital would reduce their incentive to save. However, the future path of economic output would depend not only on those marginal tax rates but also on the paths of overall spending and revenues. (For further discussion of the interaction between the two scenarios and economic output, see Chapter 1.)
CBO estimates that under the extended-baseline scenario, the marginal tax rate on labor income would increase by 5.4 percentage points between now and 2035 and then rise more slowly between 2035 and 2080 (see Table 5-2). That rate would increase in 2011 because of the expiration of EGTRRA and JGTRRA and then continue to grow because of real bracket creep under the regular tax and the growing number of taxpayers affected by the AMT. The anticipated increase in the marginal tax rate on labor from those aspects of the tax system would be partly offset by the decline in the share of compensation subject to both income and payroll taxes because of the increasing share of compensation expected to be paid as nontaxable health insurance. Under the alternative fiscal scenario, the marginal tax rate on labor income would also rise between now and 2035, but by only about a third as much as under the extended-baseline scenario. That increase would be smaller because the AMT would be indexed and EGTRRA and JGTRRA would not expire.
Estimates of the Effective Marginal Federal Tax Rates on Capital and Labor Income Under CBO’s Long-Term Budget Scenarios
| 2009 | 2035 | 2080 | ||
| Marginal Tax Rate on Labor Income | ||||
| Extended-baseline scenario | 28.8 | 34.2 | 35.1 | |
| Alternative fiscal scenario | 28.8 | 30.4 | 33.0 | |
| Marginal Tax Rate on Capital Income | ||||
| Extended-baseline scenario | 13.1 | 16.4 | 19.3 | |
| Alternative fiscal scenario | 13.1 | 14.2 | 16.5 | |
Source: Congressional Budget Office.
Notes: The effective federal marginal tax rate on income from labor is the share of the last dollar of earnings in the economy that is taken by federal individual income and payroll taxes. The effective federal marginal tax rate on income from capital is the share of the last dollar of such income that is taken by federal individual income and corporate income taxes.
The extended-baseline scenario adheres closely to current law, following CBO’s 10-year baseline budget projections from 2009 to 2019 and then extending the baseline concept for the rest of the projection period. The alternative fiscal scenario deviates from CBO’s baseline projections, beginning in 2010, by incorporating some changes in policy that are widely expected to occur and that policymakers have regularly made in the past.
The marginal tax rate on capital under the extended-baseline scenario would rise by 3.3 percentage points between 2009 and 2035 and by another 2.9 percentage points between 2035 and 2080. Under the alternative fiscal scenario, that marginal tax rate would increase by 1.1 percentage points by 2035 and by a further 2.3 percentage points between 2035 and 2080.
The Impact of Inflation and Real Income Growth
Over the next 75 years, the cumulative effect of rising prices will sharply reduce the value of some parameters of the tax system that are not indexed for inflation. For example, under the alternative fiscal scenario, the $1,000 child tax credit would be worth less than $300 (measured in 2009 dollars) by 2080. Under the extended-baseline scenario, the estate tax exemption, which will amount to $1 million in 2019, would be worth less than $300,000 (in 2009 dollars) by 2080; the same is true for the amount of mortgage debt eligible for the mortgage interest deduction under both scenarios. The portion of Social Security benefits subject to taxation would increase under both scenarios, from 24 percent now to 59 percent by 2080, because the thresholds for taxing benefits are fixed.
Even tax parameters that are indexed for inflation would lose value relative to income over the long term. The current $3,650 personal exemption would almost quadruple by 2080 because it is indexed for inflation, but income per household is projected to rise 10-fold during that period, so the value of the exemption relative to income would decline by almost 60 percent. The proportion of taxpayers claiming the earned income tax credit would fall from 14 percent this year to less than 5 percent in 2080 under both scenarios as growth in real incomes moved most taxpayers out of the eligibility range for the credit.
The fact that some tax parameters are not indexed and others are indexed only for inflation (but not real income growth) has significant implications beyond the usual tax policy horizon. Locking the current rules in place over the projection period would cause individual income taxes to change differently for taxpayers at different points in the income distribution. For example, a couple who have two children, earn the median income in 2009, and file a joint tax return pay about 4 percent of their income in individual income taxes (see Table 5-3).5 By 2080, under the extended-baseline scenario, a similar couple at that point in the distribution would pay 17 percent of their income in individual income taxes, an increase of 13 percentage points. By comparison, if the same couple earned four times the median income, the share of income they paid in individual income taxes would rise from 19 percent in 2009 to 26 percent by 2080 under the extended-baseline scenario, an increase of only 7 percentage points. Income taxes as a share of income would be rising at both points in the income distribution but by a greater proportion for the couple earning the median income.
Individual Income and Payroll Taxes as a Share of Income Under CBO’s Long-Term Budget Scenarios
| Taxes as a Share of Income (Percent) |
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| Extended-Baseline Scenario |
Alternative Fiscal Scenario |
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| Income | Income | Income and | Income | Income and | ||||||||
| (2009 dollars) | Taxes | Payroll Taxes | Taxes | Payroll Taxes | ||||||||
| Taxpayer Filing a Single Return | ||||||||||||
| Half the Median Income | ||||||||||||
| 2009 | 20,400 | 1 | 10 | 1 | 10 | |||||||
| 2035 | 31,100 | 3 | 11 | 2 | 10 | |||||||
| 2080 | 61,300 | 6 | 13 | 4 | 11 | |||||||
| Median Income | ||||||||||||
| 2009 | 40,700 | 7 | 18 | 7 | 18 | |||||||
| 2035 | 62,300 | 8 | 18 | 7 | 18 | |||||||
| 2080 | 122,600 | 16 | 26 | 11 | 21 | |||||||
| Twice the Median Income | ||||||||||||
| 2009 | 81,500 | 11 | 26 | 11 | 24 | |||||||
| 2035 | 124,500 | 15 | 27 | 13 | 25 | |||||||
| 2080 | 245,100 | 19 | 31 | 16 | 29 | |||||||
| Four Times the Median Income | ||||||||||||
| 2009 | 163,000 | 15 | 26 | 15 | 26 | |||||||
| 2035 | 249,000 | 21 | 31 | 18 | 28 | |||||||
| 2080 | 490,300 | 23 | 32 | 22 | 32 | |||||||
| Married Couple with Two Children Filing a Joint Returna | ||||||||||||
| Half the Median Income | ||||||||||||
| 2009 | 49,000 | -8 | 1 | -8 | 1 | |||||||
| 2035 | 74,500 | 4 | 12 | 1 | 9 | |||||||
| 2080 | 146,200 | 9 | 17 | 4 | 11 | |||||||
| Median Income | ||||||||||||
| 2009 | 98,100 | 4 | 16 | 4 | 16 | |||||||
| 2035 | 148,900 | 11 | 22 | 7 | 18 | |||||||
| 2080 | 292,300 | 17 | 27 | 11 | 22 | |||||||
| Twice the Median Income | ||||||||||||
| 2009 | 196,200 | 11 | 21 | 11 | 21 | |||||||
| 2035 | 297,900 | 20 | 28 | 15 | 23 | |||||||
| 2080 | 584,600 | 21 | 29 | 21 | 29 | |||||||
| Four Times the Median Income | ||||||||||||
| 2009 | 392,300 | 19 | 26 | 19 | 26 | |||||||
| 2035 | 595,800 | 23 | 29 | 22 | 28 | |||||||
| 2080 | 1,169,300 | 26 | 32 | 24 | 30 | |||||||
Source: Median income amounts are derived from the March 2008 Current Population Survey and are measured in 2009 dollars. All income is assumed to be from compensation, which includes employer-provided health insurance and the employer’s share of the payroll tax.
Notes: Taxpayers are assumed to itemize if implied itemized deductions are greater than the standard deduction.
State and local taxes are assumed to be 8 percent of wages; other deductions are assumed to be 14 percent of wages.
The extended-baseline scenario adheres closely to current law, following CBO’s 10-year baseline budget projections from 2009 to 2019 and then extending the baseline concept for the rest of the projection period. The alternative fiscal scenario deviates from CBO’s baseline projections, beginning in 2010, by incorporating some changes in policy that are widely expected to occur and that policymakers have regularly made in the past.
a. The examples for the married couple assume that only one spouse earns income.
Despite the rising average tax rates in both cases, taxpayers would be better off in 2080 because the amount of income at any given point in the income distribution would have risen significantly. Under the extended-baseline scenario, pretax income for the above couple earning the median income would have grown by 300 percent and after-tax income by 260 percent (both measured in 2009 dollars). The rise in income would dominate the increase in average tax rates.
Under the alternative fiscal scenario, average tax rates would also grow faster for taxpayers whose income put them toward the bottom of the distribution. But the increase in rates would be smaller at most points in the distribution under that scenario than under the extended-baseline scenario because the AMT would not be growing as quickly. Under both scenarios, taxes as a share of income for households at various points in the income distribution would be very different than they are today.
Technically, a taxpayer owes the regular income tax plus any amount by which the AMT exceeds the regular tax. For more information on the AMT, see Congressional Budget Office, The Alternative Minimum Tax (April 15, 2004).
The President’s budget request for 2010 envisions permanently extending certain provisions of EGTRRA and JGTRRA and permanently indexing the AMT after 2009.
To more easily compare the variant scenario with the alternative fiscal scenario, both of them exclude the scheduled elimination of the phaseout of personal exemptions and itemized deductions that occurs under the extended-baseline scenario. The variant still captures the bulk of the expirations of the tax cuts scheduled to take place after 2010, however.
If the maximum earnings for the OASDI portion were indexed only for inflation, payroll taxes would decline over time as a percentage of GDP because a greater share of wages would not be subject to the OASDI tax. Because the taxable maximum is indexed to growth in average earnings, payroll taxes remain constant as a share of GDP if there are no significant changes in the distribution of wages. However, rising wage inequality in recent years has reduced the share of wages subject to the payroll tax. For this report, CBO assumed no significant change in the wage distribution beyond a small expected increase in the share of wages earned at the top of the distribution in the next 10 years. (That assumption follows the assumptions in CBO’s 10-year baseline.) Increased wage inequality does not have a large effect on total federal revenues because lower payroll tax receipts are offset by higher receipts from the individual income tax.
The examples assume that all income received by taxpayers is labor income. For more details about the calculations, see Table 5-3.
