Historical Overview of Federal Revenues

Prior to the Great Recession, I had heard federal politics described as little more than an ongoing argument about taxes; who pays too much, who pays too little, how much should be collected, how much can be collected. The data shows, however, that while there may be a big government-small government going on, however, that is only on the spending side. The generations now in charge have voted to pay for small government, aside from the peaks of economic bubble when corporate income and capital gains taxes are pouring in. The question is “who will get the small government that has been paid for?”

In fact, right at now the federal tax burden, as a share of the economy, is lower than it has been at any point in my working life – even though spending is higher. Federal taxes are far lower as a share of GDP than in the lowest year under President Reagan, by a wide margin. I can confirm this in my own life – our own total federal, state and local burden is much lower as a share of our income than in the early 1990s, when we had far less income, no dependents, and little in charitable deductions. Even though with regard to income taxes, we don’t benefit from the sweet deals the executive class gets on capital gains or retired government workers get on New York’s state and local income taxes. At the start of the Great Recession, I had expected tax burdens to soar as the federal government, state and local governments attempted to fend off bankruptcy. While state and local taxes have increased, federal taxes have fallen. The federal data may be found in the spreadsheet linked from this post. A discussion of how we got here follows.

Looking at the “Output Table” from the spreadsheet, one finds that while Republicans talk about a typical federal tax burden at 18.0% of GDP, the only time it was that high among the representative years chosen was in 1979, during the Carter Administration, and in 1995, during the Clinton Administration – two Democratic Presidents. Among Republican Presidents, it had been that high in 1987 and 1989, during the peak years of the 1980s boom, and in 2006 and 2007, at the peak of the debt-driven 2000s boom. So while Republicans talk about federal taxes at 18.0% of GDP, that hasn’t been their policy.

In fact, one of the major reasons that this country is broke, and facing tax increases and lost federal programs, services and benefits, is because for 30 years a majority of Americans have voted for politicians who promised, and delivered, tax breaks and deals. No matter how high taxes are increased now, the revenue that would have been collected in the past can’t be made up, and the debt it cause remains. So who didn’t pay?

Let’s consider the largest federal tax, the federal personal income tax, first.

There have been many, many policy reversals on income taxes in the current political era, with the tax rates cut and increased, and deductions cut back and then expanded. Looking at the long term trend, however, over the past 30 years, adjusted for the state of the economy, federal personal income taxes have fallen as a share of GDP due to massive tax cuts by two Republican Presidents, Reagan and Bush II, and tax breaks added primarily by President Clinton.

The federal personal income tax burden was 8.5% of GDP in 1979, during the Carter Administration. One of the issues that made taxpayers angry in the 1970s was the fact that the tax brackets were not increased with inflation. That meant people were moving into higher brackets as if they were getting richer when in fact, compared with the cost of living in general, and energy in particular, they were getting poorer. Federal income tax revenues would peak at 9.15% or GDP in 1982.

At the time that people faced rising tax rates due to inflation, the federal income tax code was full of tax breaks, deductions and schemes. President Carter called it a “disgrace to the human race,” but although his party controlled both houses of Congress, with members of Congress having put in all those breaks to particular interest groups and constituents, he was unable to reform it.

Ronald Reagan pushed through “the largest tax cuts in history” early in his administration. The theory was that tax cuts would unleash massive economic growth, leading to more revenue than before. Note that by 1983 the personal income tax burden had fallen to 8.17% of GDP, however.

Reagan Administration officials were also troubled by the high spending and low saving of most Americans, and believed that taxes were the explanation. At the time, Americans were saving about 8.0% of their income, less than in the past and less than their economic competitors. Personal debt from consumer spending, including credit card debt, was deductable against federal income taxes, to induce people to spend and help the poor, who were more likely to be borrowers. All savings were fully taxed to soak the rich, who were more likely to have savings.

Beginning with the IRA, and moving on to 401Ks, 529s, and other programs, the federal government sought to shift the incentives by making middle class savings tax deferred. Later in 1986 the Reagan Administration, with bi-partisan support, pushed through an income tax simplification that cut rates but eliminated or capped most deductions. Among the deductions eliminated were those for consumer borrowing, other than mortgage loans for houses. Despite this massive shift in incentives, in a triumph of our (advertizing-driven) culture over economics the American household savings rate continued to fall, eventually reaching zero in the late 1990s through the 2000s. Federal, state and local government debts were apparently political manifestations of this same culture of buy now, pay later – or perhaps not.

After the 1986 tax reform there were only three federal income tax rates – 0%, 15%, and a top rate of 28%. Reagan’s partners in the tax simplification were two Democrats -- Richard Gephardt of Missouri in the House of Representatives and Bill Bradley of New Jersey in the Senate – who had been pushing simplification since the Carter years.

Despite a 1990 tax increase by the first President Bush, federal income tax revenues fell to 7.64% of GDP in 1993. Bush introduced the idea of phasing out deductions for higher income taxpayers, a de-facto higher tax rate for the well off. In addition, a top rate of 31.0% was added, over and above the 28.0% rate. Despite the tax increase, federal income tax revenues would remain low throughout the Bush I Administration, due to the early 1990s recession.

President Clinton’s large tax increase in 1993 lifted the federal personal income tax burden to 7.96% of GDP in 1995, still less than under President Reagan. Even higher tax rates of 36.0% and 39.6% were added back into the tax code. Federal personal income tax revenues would soar in the latter years of the Clinton Administration, but only due to a tremendous stock market bubble and its associated revenues from the rich. The federal personal income tax equaled 10.1% of GDP in 2000, but the Clinton-era tax rules wouldn’t earn nearly that much money today.

In part because Clinton would spend the rest of his administration negotiating tax breaks and deals back into the federal tax code, undoing parts of the tax simplification of 1986. Since low and moderate income tax taxpayers are better off with the standard deduction, and high income taxpayers found their tax breaks phasing out under that law and the additional phases outs under the first President Bush, most of Clinton’s new breaks favored upper middle class yuppies. My family benefitted from a few ourselves. And federal “tax expenditures” through tax breaks for things like mortgages, and the exclusion of employer provided health insurance from taxable income, continued to soar in value, far surpassing in many cases actual federal spending on benefits like housing and medical assistance for the (non-elderly) poor.

It should be noted that Clinton’s antagonist in the 1990s, Republican congressional leader Newt Gingrich, claimed that whereas government spending was “big government” tax breaks were “small government” because less actual money was collected. Presumably, therefore, a 100 percent tax, rate with so many deals for those who do what they tax code favors that only 10.0% of GDP is collected, would be small government. In any even, that is the direction that tax code went in the 1990s, albeit not that far.

In 1997, Clinton also signed a lower 15.0% tax rate for capital gains, which is the reason that wealthy people pay such low federal income taxes today. That 15.0% rate for capital gains, not the Reagan and Bush II tax cuts, is the reason candidate for President Mitt Romney pays so little in taxes, and Warren Buffett has a lower tax rate than his secretary. The deal was a huge benefit for those who were granted stock or stock options in the 1990s stock market bubble, and then sold out to institutional investors such as pension and mutual funds, scoring big at the expense of middle class savers, before the bubble burst.

In case you are wondering, I believe that the 1986 federal tax reform is one of the best things Reagan did, even if the expected increase in household savings did not occur, and undoing it was one of the worst things Clinton did, even though I benefitted personally.

The so-called Bush Tax cuts of the early 2000s had cut the federal personal income tax burden to 6.82% of GDP by 2004, far lower than under Reagan or Bush I. Rates were cut, to 35.0% from 39.6% for those at the top for example, and the higher rates kicked in at higher incomes than before. But the huge drop in tax revenues seems to be greater than one would expect from those changes alone. More likely, more and more income that was really work income with no capital at risk was being classified as capital gains under the 1997 deal.

The main justification for a lower tax rate on capital gains is that it is “double taxation.” A person works and earns income, which is taxed at the regular rates. If they spend it, they pay no additional federal income tax, but if they save it, put their hard earned money at risk of a loss, and get a gain, they are taxed a second time. However, there are plenty of people paying the 15.0% rate on money that was never theirs to start with, never taxed at ordinary income, and never at risk of a loss. The “carried interest” for those in the hedge fund and private equity industries is an example.

Which brings us to President Obama. The massive economic collapse of the Great Recession, the Bush Tax Cuts, and the Clinton-era deal to tax capital gains at preferential rates, had cut federal personal income tax revenues to just 6.34% of GDP in fiscal 2011. At that point the Bush Tax Cuts were set to expire, and the Republicans had just won a sweeping victory in the 2010 congressional election.

Obama could have just allowed the tax cuts to expire to raise revenue and cut the deficit. Instead the President cut a deal with the lame duck Congress to extend the Bush Tax Cuts AND to also cut the second largest source of federal tax revenues, the payroll tax. To understand why he did so, let’s consider the history of the payroll tax.

The payroll tax falls only on workers, both employees and the self employed, and is not paid by the retired or by those who claim their income is a capital gain. No matter how high that income happens to be. It doesn’t fall on investment income at all. The largest part of the federal payroll tax, the OASDI portion (Old Age Survivors and Disability Insurance), moreover, taxes workers more the less they earn, because all income over a certain level ($110,100 this year) is exempt. The recent history of payroll tax revenues can be explained by just two decisions – and by large-scale economic, demographic and social trends in the intervening years.

In the early 1980s, the Social Security and Medicare Hospital Insurance “trust funds” were running out of money. Then-President Ronald Reagan appointed a bi-partisan commission led by Alan Greenspan to solve the problem. Under the subsequent change in tax law, the rate for OASDI was increased from about 5.1% each for the employer and employee when Reagan took office to 6.2% each by 1990. (It is likely that the employer share is also paid by the employees in the form of lower wage gains; in any event wage increases have come more rapid for those earning more than the maximum earnings taxed over the past 30 years.) A break for the self-employed, who had previously paid less than double the employee rate, was taken away. And the Medicare Hospital Fund tax was gradually ramped up from around 1.0% of (as in the case of OASDI) a limited amount of earnings, for both the employer and employee, to 1.45% of ALL work earnings for each. (Other than hospital care, Medicare is not funded by payroll taxes, but rather is funded by beneficiary payments, the general fund and, increasingly, rising debts).

These changes, along with an increase in the retirement age, were enacted in 1983. Just after a huge cut in the federal personal income tax, which hits people harder the more they earn, the Reagan Administration had enacted a huge increase in the payroll tax, which hits people harder the less they earn. This represented a huge shift in the tax burden from the affluent to low, middle and moderate-income workers. As the payroll tax increases were phased in, payroll tax collections rose from 5.2% of GDP under Carter in Fiscal 1979 to 5.71% in 1983 under Reagan and 6.30% in 1993 under George HW Bush (I).

Although low, moderate and middle-income workers had their taxes increased, the 1983 deal was supposed to “Save Social Security.” The extra revenues were to be placed in a Social Security “Trust Fund” for use when the baby boomers retired. Therefore the shift in the tax burden was never acknowledged to have occurred. The additional money workers were paying it, it was claimed, would be paid back to them later when they were old.

In addition to the huge tax increase, in the 1980s and 1990s payroll tax revenues were boosted by the large number of baby boomers in the workforce, paying in rather than taking out. Money should have been saved for use when there were fewer workers paying in, and more retirees taking out. In reality, however, the federal government took the extra payroll tax revenue and used it to replace the federal income tax revenues lost to tax cuts, shifting the tax burden downward, and also used the added revenues to increase spending on certain things (to be discussed later). All that the “trust fund” is, in reality, is a bunch of IOUs from our parents, theoretically giving us permission to tax our children into poverty. Despite all the extra payroll tax revenues from 1983 until recently, the total federal debt did not go down. It went up.

By 2004, the representative year of the Bush II administration, payroll tax revenues had already fallen to 6.11% of GDP. Not because payroll tax rates had been cut, but because there were fewer people working and thus kicking in relative to the size of the economy, and the share of work earnings taxable under the OASDI portion of the tax fell because more money went to those at the top. The real collapse in payroll tax revenues as a share of GDP, however, happened during the Obama Administration, when the number of workers fell further. And then the administration cut the deal to cut the payroll tax rate.

In FY 2011 federal payroll tax revenues equaled just 5.29% of GDP, or about the same level as in FY 1979 before the Reagan-era increases. Meanwhile, Social Security and Medicare payments equaled 8.24% of GDP in FY 2011. That gap alone accounts for a federal deficit of 3.0% of GDP. In 1993, in contrast, federal payroll tax revenues had equaled 6.3% of GDP, while Social Security and Medicare payments had equaled 6.53% of GDP.

How is Obama’s payroll tax cut to be interpreted? I look at it this way. One could well conclude that national Republicans have been playing a dirty game with taxes. First they claim that less well off Americans are not paying their fair share, based on the federal personal income tax alone, on the grounds that the payroll tax is an “insurance payment.” But when it comes time to talk about Social Security and Medicare, Republicans treat the programs as “welfare” and now something owed, which would make the payroll tax just another tax to be used for whatever purpose. The Republicans, one might argue, have forced less well off people to accept a higher tax burden by cutting personal income taxes, threatening the programs that the affluent do not need as much such as Social Security and Medicare, and inducing the less well off to pay more to save them. Reagan cut income taxes, and a year later the working people accepted higher payroll taxes. Bush cut income taxes, and a few years later he claimed Social Security and Medicare had to be cut.

In this context, the Obama payroll tax cut can be seen as an attempt to match irresponsibility with irresponsibility. If the federal government is going to go bankrupt, the President seems to believe, the affluent aren’t going to get the less well off to pay taxes for benefits they aren’t going to get. Better bankrupt than blackmailed. The Republicans have certainly reacted as if this is the case, suddenly objecting to tax cuts when cuts in the payroll tax were up for discussion. It appears they may have been counting on those Social Security and Medicare tax revenues to pay for things other than Social Security and Medicare, after the programs were cut.

But now the federal government is facing even bigger problems. To understand what those now age 55 and over did with the Social Security and Medicare revenues, compared them with a 401K. Imagine that those over 55 deposited extra revenues into a 401K account, but then immediately “borrowed money” from that 401K account and spent it on themselves. Now the 401K account has a theoretical dollar value but no actual money, just money that had been withdrawn and is now owed. That is what the those 55 and over did with the “trust fund,” and they now say that since they are retiring those 54 and under will have to pay back the money that had been borrowed.

With in reality no money having been saved up when there were more workers, with many workers forced into early retirement by the Great Recession, with less and less of work earnings going to those who earn less than the taxable maximum under OASDI, one wonders if payroll tax revenues will increase to their former share of the economy, even if the payroll tax cut expires. Chances are at least some of the decline in payroll tax revenues is permanent, with more to come.

It isn’t just federal personal income tax revenues that have fallen as payroll tax revenues have increased; the corporate income tax, the third largest federal revenue source, has plunged at a share of GDP. Revenues from this tax equaled 2.56% of GDP in FY 1979, but just 1.32% of GDP in FY 2011.

Corporate income tax revenue is highly sensitive to the economy. When corporations lose money, they not only do not pay tax in the year of the losses, but also avoid taxes in subsequent years until their all their profits equal their previous losses. In this recession, the Obama Administration and Congress allowed corporations to offset prior losses against future gains faster and more completely. They also allowed corporations to deduct spending on new plant and equipment against their profits faster than usual, to encourage economic expansion. The result is large profits with no taxes for many companies.

In theory corporate income tax revenues will soar as a percent of GDP in a year or two, as these temporary factors run their course. They will be even higher in the future, as prior losses and investments that would have reduced taxes are used up faster.

It isn’t just the economy, however, that has cut federal corporate income tax revenues, because those revenues are lower even in similar economic years. The corporate income tax has been subject to the same type of tax cutting and tax break multiplying as the personal income tax. From 2.56% of GDP in FY 1979, corporate income tax revenues fell to 1.05% of GDP in FY 1983, as a result of tax cuts and breaks proposed by President Reagan and enacted by Congress. The Reagan Administration later cut back some of those deals as the deficit soared, and corporate income tax collections rose to 1.76% of GDP in fiscal 1993 under President Bush I and 2.12% of GDP in FY 1995 under President Clinton. The corporations got a piece of the Bush II tax cuts as well, however, and corporate income tax collections fell to 1.6% of GDP in FY 2004 before collapsing later.

There is one other trend federal tax worth mentioning – the long-term decline in federal excise taxes. Once a significant source of federal revenues – the “revenuers” weren’t after untaxed black market booze for nothing – excise tax revenue equaled 0.72% of GDP in FY 1979 but just 0.59% of GDP in FY 2004 and just 0.49% of GDP in FY 2011. The failure to increase the federal gas tax with inflation has led to periodic declines in revenues over the years, leaving the transportation trust fund weakened.

But the big decrease is in the taxation of alcohol, which provided federal revenues equal to just 0.22% of GDP in FY 1979 but just 0.06% of GDP in FY 2011. You have to wonder why there is a separate Bureau of Alcohol, Tobacco and Firearms at that rate. The alcohol lobbyists, its seems, have been very successful at the federal level, though state and local tax increases may have offset some of the savings. One argument for getting rid of prohibition during the Great Recession was the expected federal tax revenues. Now those are gone. As state and local budgets have gone south over the past decade-plus legalized gambling has spread. I wouldn’t count on that one raising much revenue in the future, either