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Learning Objectives

By the end of this section, you will be able to:

  • Differentiate among a regressive tax, a proportional tax, and a progressive tax
  • Identify major revenue sources for the U.S. federal budget

There are two main categories of taxes: those that the federal government collects and those that the state and local governments collect. What percentage the government collects and for what it uses that revenue varies greatly. The following sections will briefly explain the taxation system in the United States.

Taxes are paid by most, but not all, people who work. Even if you are part of the so-called “1099” or “gig” economy, you are considered an independent contractor and must pay taxes on the income you earn in those occupations. Taxes are also paid by consumers whenever they purchase goods and services. Taxes are used for all sorts of spending—from roads, to bridges, to schools (K–12 and public higher education), to police and other public safety functions. Taxes fund vital public services that support our communities.

Federal Taxes

Just as many Americans erroneously think that federal spending has grown considerably, many also believe that taxes have increased substantially. The top line of Figure 30.5 shows total federal taxes as a share of GDP since 1960. Although the line rises and falls, it typically remains within the range of 17% to 20% of GDP, except for 2009–2011, when taxes fell substantially below this level, due to the Great Recession.

This graph illustrates five lines, each measured as a percentage of GDP: total federal tax receipts, individual income tax, payroll taxes, excise taxes, and corporate taxes. The y-axis measures federal taxes as a percentage of GDP, from 0 to 25 percent, in increments of 5 percent. The x-axis shows years, from 1960 to 2020. The total federal tax receipts line is above all the others. It starts at around 17 percent of GDP, and moves up and down between slightly over 15 percent to 19 percent between 1960 and 2000. In 2000 it peaks at 20 percent, then it declines to 15 percent in 2004, increases in 2005 to 16 percent, decreases again to under 15 percent in 2009, increases to 17 percent in 2015, then decreases to around 16 percent in 2020. Individual income taxes start in 1960 as 7 percent of GDP, then gradually increases, with a few small increases and decreases, reaching nearly 10 percent in 2020. It then decreases to 6 percent in 2009, and increases to around 7 percent in 2020. Payroll taxes are 4 percent of GDP in 1960, then increase to 6 percent in the early 1980s, and are generally constant at that rate to 2020. Excise taxes are around 3 percent of GDP in 1960, slowly decrease over time to around 2 percent in 2020. Corporate taxes as a percentage of GDP are 3 percent in 1960, increase to 4 percent in the late 1960s, then decline over time to 1 percent in 2020.
Figure 30.5 Federal Taxes, 1960–2020 Federal tax revenues have been about 17–20% of GDP during most periods in recent decades. The primary sources of federal taxes are individual income taxes and the payroll taxes that finance Social Security and Medicare. Corporate income taxes and social insurance taxes provide smaller shares of revenue. (Source: Economic Report of the President, 2021. Table B-47,

Figure 30.5 also shows the taxation patterns for the main categories that the federal government taxes: individual income taxes, corporate income taxes, and social insurance and retirement receipts. When most people think of federal government taxes, the first tax that comes to mind is the individual income tax that is due every year on April 15 (or the first business day after). The personal income tax is the largest single source of federal government revenue, but it still represents less than half of federal tax revenue.

The second largest source of federal revenue is the payroll tax (captured in social insurance and retirement receipts), which provides funds for Social Security and Medicare. Payroll taxes have increased steadily over time. Together, the personal income tax and the payroll tax accounted for over 85% of federal tax revenues in 2020. Although personal income tax revenues account for more total revenue than the payroll tax, nearly three-quarters of households pay more in payroll taxes than in income taxes.

The income tax is a progressive tax, which means that the tax rates increase as a household’s income increases. Taxes also vary with marital status, family size, and other factors. The marginal tax rates (the tax due on all yearly income) for a single taxpayer range from 10% to 35%, depending on income, as the following Clear It Up feature explains.

Clear It Up

How does the marginal rate work?

Suppose that a single taxpayer’s income is $35,000 per year. Also suppose that income from $0 to $9,075 is taxed at 10%, income from $9,075 to $36,900 is taxed at 15%, and, finally, income from $36,900 and beyond is taxed at 25%. Since this person earns $35,000, their marginal tax rate is 15%.

The key fact here is that the federal income tax is designed so that tax rates increase as income increases, up to a certain level. The payroll taxes that support Social Security and Medicare are designed in a different way. First, the payroll taxes for Social Security are imposed at a rate of 12.4% up to a certain wage limit, set at $137,700 in 2020. Medicare, on the other hand, pays for elderly healthcare, and is fixed at 2.9%, with no upper ceiling.

In both cases, the employer and the employee split the payroll taxes. An employee only sees 6.2% deducted from their paycheck for Social Security, and 1.45% from Medicare. However, as economists are quick to point out, the employer’s half of the taxes are probably passed along to the employees in the form of lower wages, so in reality, the worker pays all of the payroll taxes. If you are a member of the “gig economy” and receive a 1099 tax statement, then you are considered an independent contractor and so you must pay the employee and employer side of the payroll tax.

We also call the Medicare payroll tax a proportional tax; that is, a flat percentage of all wages earned. The Social Security payroll tax is proportional up to the wage limit, but above that level it becomes a regressive tax, meaning that people with higher incomes pay a smaller share of their income in tax.

The third-largest source of federal tax revenue, as Figure 30.5 shows is the corporate income tax. The common name for corporate income is “profits.” Over time, corporate income tax receipts have declined as a share of GDP, from about 4% in the 1960s to an average of 1% to 2% of GDP in the past 40 years.

The federal government has a few other, smaller sources of revenue. It imposes an excise tax—that is, a tax on a particular good—on gasoline, tobacco, and alcohol. As a share of GDP, the amount the government collects from these taxes has stayed nearly constant over time, from about 2% of GDP in the 1960s to roughly 3% by 2020, according to the nonpartisan Congressional Budget Office. The government also imposes an estate and gift tax on people who pass large amounts of assets to the next generation—either after death or during life in the form of gifts. These estate and gift taxes collected about 0.2% of GDP in 2020. By a quirk of legislation, the government repealed the estate and gift tax in 2010, but reinstated it in 2011. Other federal taxes, which are also relatively small in magnitude, include tariffs the government collects on imported goods and charges for inspections of goods entering the country.

State and Local Taxes

At the state and local level, taxes have been rising as a share of GDP over the last few decades to match the gradual rise in spending, as Figure 30.6 illustrates. The main revenue sources for state and local governments are sales taxes, property taxes, and revenue passed along from the federal government, but many state and local governments also levy personal and corporate income taxes, as well as impose a wide variety of fees and charges. The specific sources of tax revenue vary widely across state and local governments. Some states rely more on property taxes, some on sales taxes, some on income taxes, and some more on revenues from the federal government.

This graph illustrates total state and local revenue as a percentage of GDP, and how it changes over time. The y-axis shows total state and local revenue as a percentage of GDP, from 0 to 18 percent, in increments of 2 percent. The x-axis measures years, from 1960 to 2018. The line starts in 1960 at slightly over 9 percent of GDP and increases steadily over 16 percent of GDP in 2012, followed by a small decrease to around 15 percent in 2018.
Figure 30.6 State and Local Tax Revenue as a Share of GDP, 1960–2020 State and local tax revenues have increased to match the rise in state and local spending. (Source: Economic Report of the President, 2020. Table B-50,
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