Increase Individual Income Tax Rates
CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.
|Billions of Dollars||2019||2020||2021||2022||2023||2024||2025||2026||2027||2028||2019-
|Change in Revenues|
|Raise all tax rates on ordinary income by 1 percentage point||55.2||82.5||86.9||91.4||95.9||100.4||105.2||95.3||94.1||98.5||411.9||905.4|
|Raise ordinary income tax rates in the four highest brackets by 1 percentage point||13.5||20.6||22.0||23.3||24.7||26.0||27.5||22.3||20.9||22.2||104.1||222.9|
|Raise ordinary income tax rates in the two highest brackets by 1 percentage point||7.2||11.0||11.6||12.3||13.0||13.7||14.4||13.2||13.1||13.9||55.1||123.4|
The 2017 tax act included a number of temporary changes to the individual income tax. For calendar years 2018 through 2025, taxable ordinary income earned by most individuals is subject to the following seven statutory rates: 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent. (Taxable ordinary income is all income subject to the individual income tax other than most long-term capital gains and dividends, minus allowable adjustments, exemptions, and deductions.) At the end of 2025, nearly all of the modifications to the individual income tax system made by the 2017 tax act are scheduled to expire, and the rates will revert to those under pre-2018 tax law. Beginning in 2026, the statutory rates will be 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent, and 39.6 percent.
As specified by the tax code, different statutory tax rates apply to different portions of people's taxable ordinary income. Tax brackets—the income ranges to which the different rates apply—vary depending on taxpayers' filing status (see table below). For 2018, for example, a person filing singly with taxable income of $40,000 would pay a tax rate of 10 percent on the first $9,525 of taxable income, 12 percent on the next $29,175, and 22 percent on the remaining $1,300. The starting points for those income ranges are adjusted, or indexed, each year to include the effects of inflation. The 2017 tax act permanently changed the measure used to adjust for inflation from the consumer price index for all urban consumers (CPI-U) to a "chained" version of the CPI-U, which grows more slowly. Like the tax rates, the tax brackets will revert to those in effect under pre-2018 law (adjusted for inflation using the chained CPI-U) in 2026.
|Starting Points for Tax Brackets (2018 dollars)||Statutory Tax Rate on Ordinary Taxable Income (Percent)|
|Single Filers||Joint Filers||2018|
Income in the form of dividends and long-term capital gains (those realized on assets held for more than a year) is taxed under a separate rate schedule, with a maximum statutory rate of 20 percent. Income from all capital gains and dividends, along with other investment income received by higher-income taxpayers, is also subject to an additional tax of 3.8 percent.
Taxpayers who are subject to the alternative minimum tax (AMT) face statutory rates of 26 percent and 28 percent. (Over certain income ranges, the effective rate on each additional dollar of income is higher than the statutory rate. The AMT works in parallel with the regular income tax; it is similarly structured but has fewer exemptions, deductions, credits, and rates. Households must calculate the amount they owe under both the AMT and the regular income tax and pay the larger of the two amounts.) However, the AMT does not affect most of the highest-income taxpayers because the highest statutory rate under the AMT is only 28 percent, and many deductions allowed under the regular income tax are also allowed under the AMT. The 2017 tax act significantly limited the reach of the AMT for calendar years 2018 through 2025 by increasing the amount of income that is exempt from the AMT and by limiting the deduction for state and local taxes under the regular income tax.
In 2016, the IRS reported that $6.6 trillion in income was taxed at ordinary rates, generating $1.4 trillion in revenues from 114 million returns. Almost a quarter ($1.6 trillion) of that income was taxed at the four highest rates, and about a tenth ($750 billion) was taxed at the two highest rates. Taxable income is projected to grow at a rate similar to gross domestic product between now and 2028, despite a drop in 2026, when temporary provisions of the 2017 tax act that affect the amount of income that is taxable are scheduled to expire. Those temporary provisions, which boost taxable income on net, include the repeal of personal exemptions, the limitation of certain itemized deductions, and an increase in the standard deduction.
This option consists of three alternative approaches for increasing statutory rates under the individual income tax. Those alternatives are as follows:
- Raise all tax rates on ordinary income (income subject to the regular rate schedule) by 1 percentage point.
- Raise all tax rates on ordinary income in the top four brackets (24 percent and over from 2018 through 2025, and 28 percent and over after 2025) by 1 percentage point.
- Raise all tax rates on ordinary income in the top two brackets (35 percent and over) by 1 percentage point.
Effects on the Budget
If implemented, the first alternative would increase revenues by a total of $905 billion from 2019 through 2028, according to estimates by the staff of the Joint Committee on Taxation (JCT). Under that alternative, for example, in 2019, the top rate of 37 percent would increase to 38 percent, and in 2026, the top rate of 39.6 percent would increase to 40.6 percent.
The second and third alternatives would target specific individual income tax rates. Because those alternatives would affect smaller groups of taxpayers, they would raise significantly less revenue. Boosting rates only on ordinary income in the top four brackets by 1 percentage point would raise revenues by $223 billion from 2019 through 2028, according to JCT—much less than the first alternative. Boosting rates only on ordinary income in the top two brackets by 1 percentage point would raise even less revenue—$123 billion over that period, in JCT's estimation. The AMT would not significantly limit the effect of that increase in regular tax rates because most people who are subject to the top rate in the regular income tax are not subject to the AMT.
The growth in revenues under all approaches would be boosted from 2018 through 2025 by the temporary changes included in the 2017 tax act. Most notably, because the 2017 tax act sharply limits the reach of the AMT from 2018 through 2025, the share of taxpayers affected by changes in ordinary income tax rates will increase during that period. Consequently, raising tax rates would raise more revenues before 2026 than after.
The estimates shown here incorporate the effects of two behavioral responses among taxpayers: shifting income from taxable forms to nontaxable or tax-deferred forms and not reporting some income. Those behaviors could include tax planning to reduce income subject to higher tax rates, tax avoidance transactions, and tax evasion. For example, an increase in the ordinary income tax rate might result in an increased use of deferred compensation or an attempt to characterize ordinary income as capital gains income. However, the estimates do not incorporate changes in how much people would work or save in response to higher tax rates. For example, an increase in tax rates would discourage people from working because it would lower after-tax wages and salaries.
The estimates for this option are uncertain for two key reasons. First, the estimates rely on the Congressional Budget Office's 10-year projections of the economy and of individual income under current law. Those projections are inherently uncertain, but they are particularly uncertain because they reflect recently enacted changes to the tax system by the 2017 tax act. Second, the estimates rely on estimates of how taxpayers would shift income and change reported income in response to the change in tax rates. Those estimates are based on observed responses to prior changes to tax rates, which might differ from the responses to tax-rate changes considered here.
As a way to boost revenues, an increase in tax rates would offer some administrative advantages over other types of tax increases because it would require only minor changes to the current tax system. Furthermore, by boosting rates only on income in higher tax brackets, the second and third alternatives would increase the progressivity of the tax system: Those alternatives would impose a larger burden on people with more financial resources than on people with fewer resources.
Rate increases also would have drawbacks, however. Higher tax rates would reduce people's incentive to work and save. In addition, higher tax rates would cause economic resources to be allocated less efficiently than they would be under current law. That is because taxpayers would shift income from taxable to nontaxable or tax-deferred forms (by substituting tax-exempt bonds for other investments, for example, or by opting for more tax-exempt fringe benefits instead of cash compensation) or increase spending on tax-deductible items relative to other items (such as by paying more toward their home mortgage interest and spending less on other things).