Where Are Tax Rates Headed?
By Roberton Williams :: December 12th, 2013
Effective tax rates have been rising since 2009 and will continue to rise for a few more years before they flatten out, according to Tax Policy Center projections.
My TaxVox post earlier this week showed how average federal tax rates have changed over the past three decades. But that was based on a 30-year history of federal tax rates produced by the Congressional Budget Office (CBO) that ends in 2010.
While we don’t know the future for certain, TPC has projected effective federal tax rates out to 2024. There are significant differences between the CBO and the TPC estimates but splicing the two projections together gives a reasonable picture of what will happen to rates for various income groups under today’s tax law.
TPC projects that average rates will rise for all income groups from their recent lows caused by the Great Recession and the tax cuts put in place to combat it (see graph). With incomes rebounding and most of the temporary stimulus tax cuts expiring earlier this year, average rates will rise by 2 or 3 percentage points between 2009 and 2015 for all but the top 1 percent, who will see a steeper 7 percentage point jump.
Rates will drift upward in subsequent years as real incomes rise. The poorest families will get hit harder in 2018 when they lose the remaining stimulus tax cuts, and the average tax rates for the top two income groups will decline as more of their income comes from capital gains and dividends, which face lower rates.
Splicing the CBO and TPC estimates together gives a longer view of what’s happening to tax rates, although we need to be cautious about comparing the two series—more on that below. Under today’s law, average tax rates will remain below their three-decade highs for every income group. However, the top 1 percent’s nearly 34 percent rate in 2016 will be close to its 35 percent peaks in 1979 and 1995. Overall, federal taxes should be at least as progressive as in the past.
The rate changes come from a combination of scheduled adjustments in the law and changes in levels and composition of income. We use CBO’s estimates of aggregate growth in wages, capital gains, and other forms of income over the next decade, and generally assume that recent trends in growth across income groups will continue. If actual incomes differ much from our assumptions, our estimates of tax rates could be far off the mark.
TPC and CBO estimates match up well for the seven years they overlap, though they do differ at the top. However, that similarity may be just chance. In fact, there are at least four major differences between the CBO and TPC estimates that could prevent them from matching up:
- Different taxes: Both analyses include individual and corporate income taxes and payroll taxes, but TPC adds estate taxes while CBO also counts excise taxes. Almost everyone pays excise taxes—think gasoline, tobacco, alcohol, and plane tickets—while estate taxes hit very few people.
- Different sources of income: CBO and TPC both include wage and salary income, investment returns, and business income. But CBO counts Medicare and Medicaid, for example, while TPC includes the returns on retirement accounts—so-called inside buildup.
- Different groupings of people: CBO looks at households—people who live together—while TPC focuses on tax units. The two are usually but not always the same.
- Different ranking methods: CBO assigns households to income percentiles based on an adjusted measure of income. TPC doesn’t adjust incomes so generally has more large units in higher income groups and more small units in lower ones.
Those differences mean that the two sets of estimates won't align perfectly. Nevertheless, it is likely that under today's tax law, average tax rates are headed sharply upward from their recession lows.