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The federal government finances its operations with taxes, fees, and other receipts collected from many different sectors of the economy. In 2022, total federal receipts are projected to total about $4.8 trillion, or 19.6 percent of gross domestic product (GDP). The largest sources of revenues are individual income taxes and payroll taxes followed by corporate income taxes. Absent changes in tax laws, the total amount of revenues generally follows the path of the economy.
To assess whether the tax system is fair or not, it is important to look at all of the taxes that people pay, not just one particular form of taxation.
For example, while it is true that many people owe little or no individual federal income tax, there are many other kinds of taxes that apply to individuals. In fact, taxpayers whose incomes are in the bottom 90 percent of all incomes pay, on average, more in payroll taxes than in income taxes. At the other end of the spectrum, high-income Americans receive a significant amount of their income from capital gains and dividends, which are taxed at lower rates than wages and salaries. However, wealthier taxpayers also face higher tax rates on their other income and indirectly bear a greater share of the corporate income tax, which significantly raises their overall effective tax rates.
On aggregate, our federal tax system is structured to be generally progressive, with higher-income taxpayers paying a larger share of their income in taxes. However, the composition of taxes paid is very different for taxpayers at different ends of the income distribution. For low-income Americans, payroll taxes and excise taxes are the major forms of taxation; for high-income Americans, individual and corporate income taxes comprise most of their tax burden.
The income tax code also contains provisions that allow individual and corporate taxpayers to reduce their tax bills. Such special provisions — deductions, exemptions, deferrals, exclusions, credits, and preferential rates — are known as tax expenditures. In 2021, tax expenditures totaled approximately $1.9 trillion. That amount equals nearly 90 percent of the revenues that the federal government actually collected in income taxes and exceeds what was spent by any single agency or spending program, including Social Security and the Department of Defense.
Just eight tax expenditures amounted to $1.2 trillion in 2020 — more than half the cost of all such expenditures combined.
|Major Tax Expenditures||Budgetary Costs
|Exclusion of pension contributions and earnings*||$225 billion|
|Exclusion of employer contributions for medical insurance and care||221 billion|
|Reduced rates of tax on dividends and long-term capital gains**||176 billion|
|Child Tax Credit (CTC)||116 billion|
|Earned Income Tax Credit (EITC)||71 billion|
|Tax credits for health insurance purchased through marketplaces||67 billion|
|Step-up basis of capital gains at death||42 billion|
|20-Percent deduction for certain Pass-through income||34 billion|
SOURCE: Office of Management and Budget, Tax Expenditures, Budget of the United States Government, Fiscal Year 2023, March 2022.
NOTES: Table does not include recovery rebate tax credits, which have now expired; such credits totaled $295 billion in 2021. *Estimate includes defined benefit plans, defined contribution plans, self-employed plans, savers’ credit, and IRAs. **Estimate includes qualified dividends, home sales, and exclusion of small corporate stock. Entries do not sum due to rounding.
© 2022 Peter G. Peterson Foundation
Tax expenditures are often referred to as "spending in disguise," because lawmakers use the tax code to direct subsidies to specific constituencies and activities. Policymakers also use tax expenditures to influence consumer and business behavior. The mortgage-interest deduction, for example, encourages taxpayers to buy homes instead of renting. Similarly, depreciation provisions for businesses encourage new purchases of equipment. In addition, because tax expenditures subsidize "favored" activities, they can distort economic decisions in ways that reduce the productivity of our economy.
Tax expenditures generally receive less scrutiny than spending programs. Most do not need annual review and approval, and therefore often remain in place for many years. With few opportunities for review and consideration, they are harder to control and less transparent than line-item spending programs. Many tax expenditures are also more valuable for people at higher marginal tax rates, so the benefits of tax expenditures often skew toward those with higher incomes.