Policy Basics: Where Do Federal Tax Revenues Come From?
Revised April 12, 2013
In fiscal year 2012, the federal government spent $3.5 trillion on the services it provides, such as national defense, health care programs like Medicare and Medicaid, Social Security benefits for the elderly and disabled, and investments in infrastructure and education, in addition to interest on the debt (see our Policy Basics on “Where Do Our Federal Tax Dollars Go?”). Of that $3.5 trillion, close to $2.5 trillion was financed by federal revenues. The remaining amount (about $1.1 trillion) was financed by borrowing; this deficit will ultimately be paid for by future taxpayers.
The three main sources of federal tax revenue are individual income taxes, payroll taxes, and corporate income taxes; other sources of tax revenue include excise taxes, the estate tax, and other taxes and fees.
Almost half of all federal revenue (46 percent) comes from individual income taxes. The income tax is generally progressive: higher-income households pay a larger share of their income in income taxes than lower-income households do.
Another 35 percent of revenue comes from payroll taxes, which are assessed on the wage or salary paychecks of almost all workers and used to fund Social Security, Medicare Hospital Insurance, and unemployment insurance. By law, employers and employees split the cost of payroll taxes, but research has shown that employers pass their portion of the cost on to workers in the form of lower wages.
Payroll taxes as a whole are regressive: they collect a higher percentage of total earnings from lower-income workers than higher-income ones. One reason is that the Social Security component of the payroll tax applied only to a worker’s first $110,100 of earnings in 2012 ($113,700 in 2013). Another reason is that payroll taxes do not apply to dividends, capital gains, or other unearned income, which constitutes a much greater portion of higher-income peoples’ earnings.
Corporate income taxes make up about 10 percent of federal revenue, with the remaining 9 percent coming from excise taxes, estate taxes, and other taxes. Excise taxes are collected on the sale of certain goods (e.g., fuel, alcohol, and tobacco); they are intended to raise revenue and, in some cases, discourage consumption of the taxed product. These made up about 3 percent of federal receipts in 2012.
The estate tax is a tax on assets such as cash, real estate, or stock that are transferred from deceased persons to their heirs. Because the first $10.24 million of a married couple’s estate was exempt from the estate tax in 2012, and because of other special exemptions from the estate tax, fewer than the wealthiest two of every 1,000 estates nationwide owed any estate tax in 2012. Estate tax revenues made up 0.6 percent of total federal receipts in 2012.
Another source of federal revenue is excess profits on assets held by the Federal Reserve System. In recent years, these have grown from only 0.8 percent of total revenue in 2005 to more than 3 percent in 2012. The increase in these receipts is due to extraordinary actions taken by the Federal Reserve to combat the financial crisis and is projected to decline in the coming years.
The small remainder of federal revenues comes from various sources such as regulatory fees and custom duties.
Over recent decades, the share of federal revenues coming from individual income plus payroll taxes has grown, while the share coming from corporate taxes and other revenues has fallen. The Great Recession — one of the worst economic downturns since the Great Depression — and the policies enacted to combat it, including temporary tax cuts, have depressed federal revenues below the typical levels of recent decades. Revenues fell from 18.5 percent of gross domestic product in 2007 to 15.8 percent in 2012. As the economy recovers and temporary tax measures expire, federal revenues are projected to return to higher levels.