Policy Basics: Where Do Federal Tax Revenues Come From?
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.
December 6, 2018
In fiscal year 2017, the federal government spent $4.0 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. Federal revenues financed over $3.3 trillion of that $4.0 trillion. Borrowing financed the remaining amount ($665 billion); future taxpayers will ultimately pay this deficit.
Almost half of all federal revenue (48 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 are 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. However, if one looks at the overall impact of Social Security, Medicare, and unemployment insurance — the benefits they provide as well as the taxes they collect — these programs are progressive.
Corporate income taxes make up about 9 percent of federal revenue, with the remaining 8 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 2017.
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 $11.0 million of a married couple’s estate was exempt from the estate tax in 2017, and because of other special exemptions from the estate tax, only the wealthiest two of every 1,000 estates nationwide owed any estate tax in 2017. (Fewer than one out of every 1,000 estates will owe the estate tax in 2018, because the 2017 tax law doubled the estate tax exemption so that the first $22.4 million of a married couple’s estate is exempt from the tax.) Estate tax revenues made up 0.7 percent of total federal receipts in 2017.
Another source of federal revenue is profits on assets held by the Federal Reserve System. These were about 2.5 percent of total revenue in 2017, compared to a recent low of 0.9 percent in 2005. 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, depressed federal revenues below the typical levels of recent decades. Revenues fell from 17.9 percent of gross domestic product in 2007 (the last fiscal year before the recession) to 14.6 percent in 2009 and 2010. Revenues have recovered with the economy and were 17.3 percent of gross domestic product in 2017. However, revenues are projected to decline to 16.5 percent of GDP in 2019 — well below the prior 40-year average of 17.4 percent of GDP — largely due to the enactment of the 2017 tax law.