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Reducing the Deficit: Spending and Revenue Options March 1997

Revenues are the other side of the federal budget equation. In 1996, federal revenues were $1.45 trillion compared with outlays of $1.56 trillion. With no change in current policies governing taxes, the Congressional Budget Office (CBO) expects that revenues will grow to $1.51 trillion in 1997 and to $1.86 trillion by 2002 (see Table 6-1).

Over 90 percent of federal revenues come from income and payroll taxes. In 1996, the individual income tax alone raised 45 percent of federal revenue. Social insurance payroll taxes raised 35 percent, and the corporate income tax raised 12 percent. Excise taxes raised an additional 4 percent of federal revenue, and the rest came from estate and gift taxes, customs duties, and fees and other miscellaneous receipts.

Federal revenues claimed 19.4 percent of gross domestic product (GDP) in 1996, well above the average revenue share of 18.1 percent recorded since 1960. The Congressional Budget Office expects the federal revenue share of GDP to decline gradually over the next five years under current law, reaching 18.8 percent of GDP in 2002, which is still above its historical average. Most of that decline stems from an expected decrease in the GDP share of corporate income taxes and excise taxes.

This chapter presents a broad range of options for increasing federal revenue. The options would raise revenue from all of the major revenue sources. They differ in the way they would affect how economic resources are allocated among various uses and how tax burdens are allocated among taxpayers. In using combinations of options, however, some cautions should be observed. Because a number of options are variations of the same theme, certain combinations would not be appropriate. Moreover, some combinations of options would compound any adverse economic incentives arising from changes in tax rules.

The estimates assume that taxpayers would change their behavior in a variety of ways in response to tax increases. For example, higher taxes on alcohol or tobacco would lead to reduced consumption of those goods, whereas higher income tax rates would lead to a shift in income from taxable to nontaxable forms, de-ferral of income, and greater use of deductions. The estimates do not attempt to assign a numerical value to any feedback to the overall economy from, for example, changes in investment or work behavior. Although such feedback might occur, most options involve small changes, and their impacts would probably not affect economic activity enough to be noticed in the $8 trillion U.S. economy. Broad-reaching options--such as intro-ducing a federal value-added tax--would have effects on the entire economy over time, but the size and timing of those effects are highly uncertain.

Options for raising revenues would appear to be headed against both the Administration and Congres-sional tide of revenue-reducing proposals introduced over the past two years. However, for a variety of reasons, the Congress may wish to consider certain revenue-raising options. First, relying on spending cuts alone may prove to be difficult in assembling a bal-anced budget proposal. Second, many options would raise revenue by eliminating or curtailing certain pref-erences in the tax code. Those steps would not only achieve deficit reduction, but also reduce the com-plexity of the tax code and provide more even-handed treatment of taxpayers. Third, revenues from removing tax preferences could be used to pay for tax reductions that would be more neutral in their effects. Alterna-tively, such revenues could substitute for cutbacks in spending programs supporting the same or related activities.


Trends and International Comparisons

The federal revenue share of GDP has dropped as low as 17 percent and risen almost as high as 20 percent since 1960 (see Figure 6-1). The revenue share reached its peak in 1969, when the Congress enacted an income tax surcharge during the Vietnam War, and again in 1981 after several years of rapid inflation pushed taxpayers' incomes into higher tax brackets ("bracket creep"). Large personal and corporate tax reductions enacted in the Economic Recovery Tax Act of 1981, combined with back-to-back recessions in 1980 and 1981 to 1982, brought the revenue share down to well under 18 percent in 1983 and 1984.

In subsequent years, the revenue share rose above 18 percent before falling below that level as a result of the 1990-1991 recession and the slow recovery that followed. That drop more than offset the tax increases enacted in the Omnibus Budget Reconciliation Act of

1990 (OBRA-90). The revenue share rebounded in 1994 as the economy improved and the tax increases enacted in the Omnibus Budget Reconciliation Act of 1993 (OBRA-93) took effect.

At 19.4 percent of GDP, the revenue share in 1996 was just below its highest level recorded since 1960. A number of factors contributed to the higher than usual revenue share in 1996. In addition to the OBRA-93 tax increases, the economy was generally strong. Corpo-rate profits, in particular, reached levels relative to the size of the economy that had not been recorded in over 25 years.

In addition to the fluctuations of revenues as a share of GDP, important shifts have occurred over the last 35 years in the composition of revenues (see Figure 6-2). Individual income taxes--the largest component of total revenues--have fluctuated between about 7 per-cent and 9.5 percent of GDP since 1960. At 8.8 per-cent of GDP in 1996, the share of individual income taxes is currently in the high end of that range. Individ-ual income taxes as a share of GDP rose sharply in the 1979-1982 period, when rapid inflation led to bracket creep that pushed up revenues, which peaked at 9.4 per-cent of GDP in 1981. Since the early 1980s, individual income taxes as a share of GDP have stayed below 9 percent. Barring any new legislation affecting reve-nues, CBO expects that individual income tax revenues 

Figure 6-1.
Total Revenue as a Share of GDP
 

will claim almost 8.7 percent of GDP a year through 2002.

The share of GDP claimed by corporate income taxes fell between 1960 and the mid-1980s both because of a drop in corporate profits as a share of GDP and legislated reductions in tax liability. The share averaged just below 4 percent in the 1960s, 3 percent in the 1970s, and 2 percent in the 1980s. Corporate taxes as a share of GDP have grown slightly since the Congress raised corporate taxes in the Tax Reform Act of 1986. With corporate profits as a share of GDP at its highest level since 1969, its tax share of GDP was up even more in 1996. CBO expects that the revenue share of corporate taxes will decline gradually from 2.3 percent of GDP in 1996 to 2 percent in 2002.

The share of GDP claimed by social insurance taxes (mostly the Social Security payroll tax) increased steadily between 1960 and the late 1980s, as tax rates, coverage, and the share of wages subject to taxation all grew. The share swelled from just under 3 percent of GDP in 1960 to nearly 7 percent by 1988--about where it is today. Social insurance tax revenues were equal to about 25 percent of combined individual and corporate income tax revenues in 1960, about 50 percent of combined income tax revenues in 1980, and over 60 percent today.

Excise taxes--levied on such goods and services as gasoline, alcohol, tobacco, and telephone use--represent a small share of total federal revenues. Excises have claimed a decreasing share of GDP over time largely because most are levied on the quantity--not the value--of goods, and rates have not generally kept pace with inflation.

Taxes at all levels of government--federal, state, and local--amounted to nearly 30 percent of GDP in 1994. By way of comparison, the tax share of GDP for member countries of the Organization for Economic Cooperation and Development (OECD)--comprising most of the major industrialized, market-economy countries in the world--averaged nearly 40 percent in 1994 (see Figure 6-3).

Indeed, the composition of tax revenues in the United States is quite different from that in most OECD member countries. The most significant differ-ence is the greater reliance on taxes on goods and ser-vices in most other countries, particularly general con-sumption taxes such as the value-added tax (VAT). Australia and the United States are the only OECD countries without a VAT, although Australia does levy a general consumption tax in the form of a sales tax at the wholesale level. The United States has no general consumption tax at the federal level, but 45 states and the District of Columbia have a general sales tax.

General consumption taxes at all levels of govern-ment accounted for less than 8 percent of total tax rev-enues in the United States in 1994, compared with 17.5 percent of total tax revenue in OECD member countries (see Figure 6-4). Of all the member countries, only Japan had a lower percentage of revenues raised by general consumption taxes than the United States. All taxes on goods and services, which include specific ex-cise taxes as well as general consumption taxes, made up about 18 percent of total tax revenues in the United States compared with an average of 32 percent in OECD member countries. Despite a heavier reliance on consumption taxes than in the United States, revenue from income taxes, including taxes on corporate profits, are still a significant share of total revenues in OECD

SOURCE: Congressional Budget Office.

Figure 6-3.
Total Tax Revenues as a Percentage of GDP, 1994
 

a. Unweighted average.

member countries, averaging about one-third of rev-enues among European members, and one-half of revenues among Pacific Ocean members.


Revenue-Raising Options

The revenue options in this chapter are grouped accord-ing to a number of broad categories. The first set of options, REV-01 through REV-03, would raise reve-nues by simply raising income tax rates. Options REV-04 through REV-08 would remove certain preferences and broaden the individual income tax by restricting itemized deductions and credits. Options REV-09 through REV-17 would also remove tax preferences and broaden the individual income tax base but would do so by extending taxes to currently nontaxable employer-paid fringe benefits, and restricting the tax-favored treatment of certain types of household income.

With the release of the final report of the 1994-1996 Advisory Council on Social Security in January of this year, the Congress may address the issue of the future solvency of the Social Security and Medicare trust funds in this session. The Advisory Council report included tax options that would make major changes in the financing of Social Security. Although such options are beyond the scope of this chapter, certain more limited options presented here, such as REV-18 through REV-20, would contribute to the long-term solvency of those funds.

In 1996, the Congress eliminated several income tax preferences for businesses, most notably those for investment in U.S. possessions and corporate-owned life insurance. The preferences were eliminated to finance the enactment of certain tax incentives for investment by small businesses and for purchase of additional types of health insurance. Options REV-26 through REV-33 would curtail other income tax preferences for businesses.

Some Members of Congress seek more dramatic changes in the way the federal government raises reve-nues that go beyond changing features of the current tax structure or removing certain preferences in the cur-rent code. Those changes include a full or partial replacement of income taxes with a general consumption tax in the interests of increasing national saving and reducing the complexity of the tax system. Clearly, such changes would constitute a sweeping overhaul of the nation's tax laws. It would affect many areas of the economy as well as revenue collection, not only at the federal level but also at the state and local levels.

This volume does not address comprehensive tax reform. Such a complex change would call for extensive analysis, and most proposals for comprehensive tax reform seek to maintain revenue neutrality rather than an increase in revenues. Certain options presented here, however, would increase the share of revenues collected from consumption-based taxes. For example, REV-34 would impose a value-added tax, whereas REV-35 would add a broad-based tax on energy. Both options assume that the current income tax system would remain in place.

The volume's revenue options differ in their implications for the cost of administration by the Internal Revenue Service and the cost of compliance by tax-payers. Some of the options would raise revenue from existing tax sources by increasing tax rates, broadening tax bases, or expanding tax coverage to include additional taxpayers. The government could put many of those options into place quickly and easily because the taxes are already in operation. Other options that would raise revenue from new tax sources, such as the federal value-added tax or broad-based energy tax, could impose substantial added compliance costs on taxpayers and administrative costs on the federal government because they would require additional tax computation methods and more Internal Revenue Service employees.

Certain options--such as REV-09, the first part of REV-18, and REV-19--would impose new mandates on state and local governments in their role as employers. Almost all of the options would impose mandates on the private sector. The Unfunded Mandates Reform Act of 1995 requires that CBO provide estimates of intergovernmental and private-sector mandates for new legislation. (The act exempts Social Security taxes.) The act imposes procedural hurdles on Congressional consideration of any legislative proposal that contains unfunded intergovernmental mandates in excess of $50 million for any of the first five years.

One revenue-raising option--to make all entitlement payments subject to the individual income tax--appears not in this chapter but in Chapter 4, which discusses entitlement payments and other mandatory spending. That option is part of ENT-45, which would apply a means test to federal entitlement payments.

Although most of the spending options presented in this volume would take effect on October 1, 1997, all but one of the revenue options would take effect on January 1, 1998. The VAT option has a later effective date because putting the tax in place would take more time. The revenue estimates for the options, most of which the Joint Committee on Taxation prepared, may differ from estimates for similar provisions in actual tax legislation as a result of differences in effective dates, transition rules, and technical details.

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