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Choosing the Nation’s Fiscal Future
Security and Medicare (often referred to as social insurance taxes). These three taxes account for 93 percent of federal revenues. Federal payroll taxes rose rapidly from the 1960s to the 1980s with the expansion of Social Security and the introduction of Medicare, but as a share of GDP they have leveled off since then. While receipts from the payroll taxes were increasing, those from the corporate income tax were declining as a percentage of GDP, leaving total revenues roughly flat. The payroll taxes are earmarked to finance rising current and future health and retirement benefits; corporate income taxes are not earmarked. Therefore, the ostensibly equal exchange of corporate income tax for payroll tax receipts—the latter linked to higher health and retirement spending—arguably left the federal budget worse off for the long term.2
Complexity of the Tax Code
The individual income tax is imposed on wages and salaries, returns from savings, small business profits, and other sources of income under a graduated rate structure.3 In 2009, statutory or explicit tax rates ranged from 10 to 35 percent. A substantial share of low-income workers and families pay no income tax because, with exemptions and the usual deductions, their modest earnings are not subject to even the lowest rate. The corporate income tax imposes a rate of 35 percent on corporate profits, with small corporations paying lower rates.
Average tax rates—which are simply taxes paid divided by total income—are almost always lower than the statutory rates because they include the effects of deductions and exemptions. Yet another important type of tax rate is the “marginal” rate, which is the rate a taxpayer pays on an additional dollar of income. For example, for a person earning $60,000 who pays $6,000 in federal income tax, the average tax rate is 10 percent. But if this person is in the 25 percent federal tax bracket (and no other features of the tax code affect tax liability) then the rate on any additional income earned, the marginal rate, is 25 percent. Because marginal rates determine the after-tax returns from work, savings, and investment, they affect the willingness to undertake such activities.4
For the typical individual income taxpayer, with moderate amounts of wage income and modest deductions from an owner-occupied home, the income tax can be relatively simple. But for some taxpayers, particularly small business owners, the income tax is often quite complex. Federal tax rules spanned 70,320 pages in 2009—one measure of their complexity—three times more than in the 1970s (CCH Canadian Limited, 2009).
In part the income tax is so intricate because “income” is difficult to define and measure; partly for the same reason, the current income tax base does not reflect a consistent definition of income. Indeed, the current income