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The following is an analysis of the Revenue section of the January 2001 CBO Budget and Economic Outlook. The text in *RED are comments included by the website host.

The Budget and Economic Outlook: Fiscal Years 2002-2011
January 2001
Section 5 of 15

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Chapter Three

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The Revenue Outlook

The Congressional Budget Office estimates that total federal revenues will exceed $2.1 trillion in fiscal year 2001 * (Actual was $1.991 trillion) if current policies remain unchanged, marking the ninth consecutive year in which the growth of revenues has outstripped the growth of the nation's gross domestic product (see Figure 3-1). Revenues are expected to grow more slowly than GDP (nominal) through 2007 and then faster than GDP through 2011 * (CBO has previously stated the out years are hardest to project). In that year, revenues are projected to be $3.4 trillion, or about 20.4 percent of GDP. * ( 20.4% is a high rate when compared to historical averages.)

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Figure 3-1.
Annual Growth of Federal Revenues and GDP, Fiscal Years 1960-2011

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SOURCE: Congressional Budget Office.

CBO expects that the growth of receipts will be slower than the rapid pace of the past few years. From 1994 to 2000, revenues rose at an average annual rate of 8.3 percent, much faster than GDP * (What was the tax policy in effect to allow tax revenues to rise higher than GDP? Is it the graduated income tax rate or is it a tax not based on GDP?) In 2000, at 10.8 percent, the growth of receipts was faster than in any year since 1987 (when growth was subject to a one-time boost from the Tax Reform Act of 1986). * (Again, was there a tax policy change to cause the 2000 increase as cited for 1987?) Consequently, as a share of GDP, revenues rose from 18.1 percent in 1994 to a post-World War II high of 20.6 percent in 2000--a level exceeded only once, in 1944 (see Figure 3-2). * (How did this happen?)

Although slowing in 2001, the growth of receipts, projected at 5.4 percent over the previous year, still outpaces the projected growth of GDP, pushing the ratio of receipts to GDP to 20.7 percent in 2001 * (Actual 2001 was 19.7%), which is expected * (“Expected” but did not happen) to become the new postwar peak. In 2002, the growth of receipts is projected to slow further, to 4.7 percent--less than the growth of GDP--so as a percentage of GDP, receipts will slip to 20.5 percent * (Actual 2002 was 17.7% but there was some tax law changes). The growth of receipts remains at about that rate through 2007 but as a percentage of GDP continues to fall, to 20.2 percent. After 2007, the growth of receipts is expected to rise, to 5.4 percent in 2011, and to increase relative to GDP, reaching 20.4 percent by the end of the projection period.

The current revenue outlook is $919 billion higher through 2010 than CBO projected last July (see Table 3-1). About seven-eighths of that increase--or about $800 billion--stems from changes in CBO's economic forecast * (In spite of the acknowledging a slow down, CBO is estimating an increase in revenues based on the economic forecast), which causes a boost in receipts from individual and corporate income and social insurance taxes. The net effect of recently enacted legislation--primarily the Community Renewal Tax Relief Act of 2000 (H.R. 5662) and the FSC (Foreign Sales Corporation) Repeal and Extraterritorial Income Exclusion Act of 2000 (H.R. 4986)--reduces projected revenues by about $37 billion over the 10 years from 2001 to 2010. The remainder of the increase since July results from a number of adjustments in the methodology and assumptions that determine how much tax is generated by the tax base. * (CBO notes there have been adjustments in assumptions resulting in higher revenue projections.) Those technical revisions total $153 billion over the 10 years.

Table 3-1. Changes in CBO's Projections of Revenues Since July 2000 (By fiscal year, in billions of dollars)
		2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	Total, 2001- 2010
July 2000 Projection of Revenues		2,109	2,202	2,290	2,380	2,486	2,594	2,706	2,826	2,960	3,102	n.a.
Legislative Changes
Individual Income		-1	-1	-2	-2	-2	-2	-3	-3	-3	-3	-22
Corporate Income		0	-1	-1	-1	-1	-1	-2	-2	-2	-2	-14
Other		-1	-1	0	0	0	0	0	0	0	0	-1
	Subtotal	-2	-2	-3	-3	-3	-4	-4	-5	-6	-5	-37
Economic Changes
Individual Income		-4	-1	10	22	31	41	51	61	72	84	366
Corporate Income		4	15	24	29	31	33	36	42	49	58	319
Social Insurance		-3	-2	2	8	12	16	20	26	30	33	143
Other		-4	-5	-4	-3	-2	-2	-1	-1	-2	-2	-26
	Subtotal	-6	7	32	56	72	88	106	128	148	173	802
Technical Changes
Individual Income		25	20	12	8	5	2	0	-2	-4	-6	60
Corporate Income		11	11	10	10	10	9	8	8	7	6	90
Other		-3	-1	1	1	1	0	1	2	1	2	4
	Subtotal	33	29	24	20	15	11	9	7	4	2	153
Total Changes
All Sources		25	34	53	73	84	95	110	129	146	170	919
January 2001 Projection of Revenues		2,135	2,236	2,343	2,453	2,570	2,689	2,816	2,955	3,107	3,271	n.a.
SOURCE: Congressional Budget Office.
NOTE: n.a. = not applicable.

Federal revenues consist of individual income taxes, corporate income taxes, social insurance taxes, excise taxes, estate and gift taxes, customs duties, and miscellaneous receipts. Individual income taxes produce about half of total revenues, an amount equal to roughly 10 percent of GDP (see Table 3-2 and Figure 3-3). Corporate income taxes contribute about a tenth of revenues, equaling approximately 2 percent of GDP. Social insurance taxes (including Social Security taxes, which are off-budget) are the second largest source of revenues, equaling about a third of total receipts and less than 7 percent of GDP. Other taxes and miscellaneous receipts, including profits from the Federal Reserve System, make up the balance.

Table 3-2. CBO's Projections of Revenues (By fiscal year)
			Actual 2000	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
In Billions of Dollars
Individual Income			1,004	1,076	1,125	1,176	1,230	1,289	1,354	1,424	1,500	1,583	1,675	1,774
Corporate Income			207	215	217	226	236	246	255	264	276	289	303	319
Social Insurance			653	686	725	762	797	840	879	921	963	1,010	1,059	1,110
Excise			69	71	74	76	78	81	83	86	88	91	94	97
Estate and Gift			29	30	32	34	35	36	37	39	43	46	48	52
Customs Duties			20	21	23	24	25	26	27	27	28	29	30	31
Miscellaneous			43	36	41	44	51	52	54	55	57	59	61	63
	Total		2,025	2,135	2,236	2,343	2,453	2,570	2,689	2,816	2,955	3,107	3,271	3,447
		On-budget	1,545	1,630	1,703	1,782	1,864	1,950	2,040	2,136	2,243	2,360	2,489	2,628
		Off-budget^a	481	504	532	561	589	620	649	680	712	746	782	819
As a Percentage of GDP
Individual Income			10.2	10.4	10.3	10.2	10.2	10.2	10.2	10.2	10.3	10.3	10.4	10.5
Corporate Income			2.1	2.1	2.0	2.0	2.0	1.9	1.9	1.9	1.9	1.9	1.9	1.9
Social Insurance			6.6	6.6	6.7	6.6	6.6	6.6	6.6	6.6	6.6	6.6	6.6	6.6
Excise			0.7	0.7	0.7	0.7	0.6	0.6	0.6	0.6	0.6	0.6	0.6	0.6
Estate and Gift			0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3
Customs Duties			0.2	0.2	0.2	0.2	0.2	0.2	0.2	0.2	0.2	0.2	0.2	0.2
Miscellaneous			0.4	0.3	0.4	0.4	0.4	0.4	0.4	0.4	0.4	0.4	0.4	0.4
	Total		20.6	20.7	20.5	20.4	20.3	20.3	20.2	20.2	20.2	20.3	20.3	20.4
		On-budget	15.7	15.8	15.7	15.5	15.5	15.4	15.4	15.3	15.3	15.4	15.5	15.5
		Off-budget^a	4.9	4.9	4.9	4.9	4.9	4.9	4.9	4.9	4.9	4.9	4.9	4.8
SOURCE: Congressional Budget Office.
a. Social Security.

* You will see the 20+% revenues to GDP occurred in 1944 and 2000. Presumably based on only 2000 the CBO expected historical revenue to GDP rates for the next 10 years.

* Based on the above graph the CBO is projecting Individual Income Taxes as a percentage of GDP to maintain its historic high rate set in 2000.

• Individual income tax receipts, bolstered primarily by higher realizations of capital gains * (capital gains are not a function of GDP) and increases in the effective tax rate, have fueled the rapid growth of revenues relative to GDP over the past few years. Because those trends are not expected to continue, the growth of revenues will slow over the next few years. The higher realizations of capital gains stemmed largely from the sharp rise in stock prices. Increases in the effective tax rate were the result of growth in real incomes generally, which increased the amount of income taxed at higher marginal tax rates (the tax rates that apply to an additional dollar of income), and of a rapid rise in income among high-income taxpayers, who are taxed at higher marginal rates * (CBO is basing the higher revenue projections on individuals earning enough to be taxed at higher marginal tax rates. Also, the CBO is basing the projections on the benefits derived from the rapid rise among high-income taxpayers.)

Although the growth of individual income tax receipts is projected to slow as capital gains in particular play a smaller role in boosting receipts, higher nominal income raises the average effective tax rate as the number of taxpayers affected by the alternative minimum tax (AMT) increases and growth in real income subjects more income to higher marginal tax rates. * (Growth in real income and exposure to the AMT are the assumptions for being able to maintain historic levels of revenues to GDP.) For the first half of the projection period of fiscal years 2001 to 2011, the depressing effect of slackening capital gains overwhelms the effect of a rising effective tax rate, lowering individual income tax receipts as a share of GDP * (Wait! This is not reflected in Table 3-2. Individual income taxes make up 10+% through the entire projection period. The historical average is well below 10%. Thereafter, the increase in the effective tax rate is the more important effect, so the share of GDP rises. That pattern tends to drive the ratio of total receipts to GDP, largely dominating the effects of corporate income taxes and excise taxes, which tend to fall relative to GDP over the 11 years.

• Corporate income taxes contributed somewhat to the increase in revenues in the 1990s, as profits improved over their performance of the 1970s and 1980s. But from 2001 to 2011, profits are projected to recede from the unusually high levels of the late 1990s. As a result, projected corporate income tax receipts as a percentage of GDP are expected to fall somewhat from 2.1 percent to 1.9 percent.
• Social insurance taxes, consisting largely of taxes for the Medicare program and Social Security, have changed little as a share of GDP in the past decade. From 2001 to 2011, they are also expected to remain essentially stable at about 6.6 percent of GDP.
• Excise taxes, although a relatively small revenue source, are expected to reduce receipts as a share of GDP during the projection period, dropping from 0.7 percent to 0.6 percent of GDP from 2001 to 2011. That share falls because many excise taxes are levied per unit or transaction rather than as a percentage of value. Receipts, therefore, tend to rise mainly with increases in real, rather than nominal, GDP. * (need a schedule)
• All other revenue sources--estate and gift taxes; customs duties; and miscellaneous receipts, including receipts from the Federal Reserve System--are expected to remain just under 1 percent of GDP throughout the projection period. * (need a schedule)

Individual Income Taxes

Individual income taxes account for most of the recent rise in revenues as a percentage of GDP. From 1993 to 1998, those receipts averaged growth of more than 10 percent a year. In fiscal year 1999, partly because of the tax cuts enacted in the Taxpayer Relief Act of 1997, they slowed to their lowest rate of increase since 1992. But in fiscal year 2000, they jumped more than 14 percent, reaching their highest share of GDP ever. * (Individual income taxes are their highest level ever even after the Taxpayer Relief Act of 1997? Interesting point of interest.) Their share is expected to peak in 2001 and then to slowly recede as some of the factors that caused the rise moderate. But in 2006, the factors tending to boost the share of individual tax receipts begin to dominate, so by 2011, those receipts as a percentage of GDP reach a new historical peak. * (CBO is projecting highest revenue receipts in the out years, the hardest years to project.)

Individual income tax projections over the 2001-2010 period are about $400 billion higher than in July. More than $350 billion of that change is due to the revised economic forecast. * (CBO is projecting an improved economic forecast, in spite of the current slow down.) About $60 billion of the increase is from technical changes, most importantly revisions in the capital gains projection, adjustments for unexplained higher-than-expected tax collections since July * (CBO acknowledges there are increased tax receipts from July-December 2000 that are unexplained), and some minor changes in CBO's methodology. Legislation reduced the projections by about $20 billion.

Sources of Recent Growth in Individual Income Taxes

Historically, individual income taxes have tended to grow only slightly faster than GDP, with few exceptions. In 1969, for example, a surtax caused income tax receipts to increase significantly faster than GDP; and before the tax code was indexed, inflation pushed the growth of income tax receipts well above that of the economy by effectively decreasing the levels of real income at which higher tax rates applied. But those phenomena were largely temporary and were followed by years in which the growth of income tax receipts fell below that of GDP. From 1994 to 2000, however, the annual growth of those receipts surpassed that of the economy for reasons unrelated to new tax legislation. In fact, in 1998 and 1999, receipts increased as a percentage of GDP despite new tax breaks concerning children and education. * (A critical Point here. The CBO is stating the tax percentage to GDP is growing in spite of tax legislation to reduce the rate. This phenomenon is not explained by historical evidence.)

CBO examined a sample of detailed tax-return data to identify the sources of the recent growth in individual income tax liabilities as a percentage of GDP. Liabilities (what taxpayers determine they owe to the government) roughly translate into receipts (what the government receives). An analysis of tax years (the years in which the tax liabilities are incurred) 1994 through 1998 attributes the surge to four sources. (As described below, Table 3-3 traces the share of the growth attributable to each of the four sources.)⁽¹⁾
* Does this mean the same tax payers tax returns were analyzed over the period 1995-1998? If so, how was the normal increase in salary based on experience discounted in this study?

Table 3-3. Shares of Growth of Individual Income Tax Liabilities in Excess of Growth of GDP, by Source, Tax Years 1995-1998 (In percent)
Source of Growth of Tax Liabilities			1995	1996	1997	1998^a	Total, 1995- 1998^a
Taxable Personal Income (TPI) Grew Faster Than GDP			21	12	14	33	20
Adjusted Gross Income (AGI) Grew Faster than TPI
	Capital gains taxes grew faster than TPI		21	52	30	15	30
	Other AGI grew faster than TPI		14	4	9	2	6
Changes in the Effective Rate on AGI
	Effect of real growth on rate		21	17	27	29	24
	Growth in incomes of high-income taxpayers		23	15	20	21	20
		Total	100	100	100	100	100
Memorandum:
Growth of Individual Income Tax Liabilities in Excess of Growth of GDP (Billions of dollars)			27	39	35	40	141
SOURCE: Congressional Budget Office using data from the Internal Revenue Service's Statistics of Income, 1994-1998.
a. The estimates of 1998 tax liabilities do not include the child and education credits enacted in the Taxpayer Relief Act of 1997.

The first significant source of the increase in individual income tax liabilities as a percentage of GDP was the rapid growth of components of GDP that are taxable to individuals. (For more information on the relationship between tax liability, taxable income, and GDP, see Box 3-1.) Taxable personal income--the sum of wages, interest, dividends, proprietors' income, and rental income, as measured in the national income and product accounts (NIPAs)--grew faster than GDP from 1994 to 1998. The resulting rise in the proportion of taxable personal income in GDP raised the tax base for individual income taxes and accounted for roughly 20 percent of the growth of tax liabilities in excess of the growth of GDP over that period.

Box 3-1.

Tax Bases and Tax Liability

The ratio of tax receipts to gross domestic product (GDP) varies for reasons other than changes in tax law. In particular, the bases on which taxes are imposed differ from GDP, and their growth is sometimes faster or slower than that of GDP. Although the bases for taxes on individual and corporate income and social insurance are similar to gross domestic product, they differ from GDP in a number of important respects.

Individual Income Tax Base

Taxable personal income is the first approximation of the individual income tax base. It comprises dividends, interest, wages and salaries, rent, and proprietors' income. It does not include depreciation, indirect business taxes, fringe benefits, or retained corporate profits.

Not all of that income is taxed, however. Some accrues to tax-exempt entities such as hospitals, schools, cultural institutions, and foundations; some is earned in a form that is tax-exempt, such as income from state and local bonds; and some is tax-deferred, such as income from retirement accounts. Also, personal interest and rental income contain large components of imputed income--income that is not earned in a cash transaction, including personal earnings within pension funds and life insurance policies and from owner-occupied housing--which is not taxable. Consequently, a large amount of interest, dividend, and rental income is excluded from the taxable base of the income tax.

Taxpayers make further adjustments, both additions and subtractions, to taxable personal income to derive adjusted gross income (AGI). Capital gains realizations--the increase in the value of assets between the time they are purchased and sold--are added to taxable personal income. Contributions from income to tax-deductible individual retirement accounts and 401(k) programs are excluded, but distributions to retirees from those programs are included. Taxpayers also make a variety of other, smaller adjustments.

Exemptions and deductions are subtracted from AGI to yield taxable income, which is then subject to progressive tax rates (that is, rates that rise as income rises). The resulting tax may then be subject to further adjustments in the form of credits, such as the child tax credit for taxpayers with children under 17, which reduce the taxpayers' tax liability. An important factor in calculating individual tax liability is the alternative minimum tax (AMT), which requires some taxpayers to calculate their taxes under a more limited set of exemptions, deductions, and credits. Taxpayers then pay the higher of the AMT or the ordinary tax. The ratio of tax liability to AGI is called the effective tax rate on AGI.

Corporate Income Tax Base

Corporate income in GDP is calculated on the basis of economic depreciation--the dollar value of productive capital assets that have been used up. For tax purposes, however, corporations calculate book profits. Those profits are calculated on the basis of book, or tax, depreciation, which is typically more generous than economic depreciation; that is, the capital is assumed to be used up faster than it actually is, allowing firms a greater reduction in their reported (and therefore taxable) profits.

The measure of book profits must then be adjusted to remove profits of the Federal Reserve System, which are counted with corporate profits in the national accounts but as federal revenues, as miscellaneous receipts, in the budget. They are also adjusted to allow for the taxation of U.S. income earned by foreign corporations and the deferral of most foreign income earned by U.S. corporations. Those and other, smaller adjustments yield taxable income for corporations. If taxable income is negative (that is, the firm loses money), the loss (within limits) may be carried back or forward to be netted against previous or future taxable income to lower taxes in those other years. A tax rate is applied to determine tax liability, which credits may reduce further. The ratio of corporate taxes to taxable income is the average tax rate.

Social Insurance Tax Base

Social insurance taxes, the other big source of receipts, use payroll as their base. Those taxes largely fund Social Security and Hospital Insurance (Part A of Medicare). Social Security taxes are imposed as a percentage of pay up to a taxable maximum that is indexed for wage growth in the economy. Medicare's Hospital Insurance taxes are not subject to a taxable maximum.

Despite the many adjustments that must be made to calculate the true tax bases, a ready approximation is the sum of wages and salaries and corporate book profits (see Chapter 2). Those items pick up much of the bases of the individual income, corporate income, and social insurance taxes and therefore constitute the bulk of taxed income.

The next two sources are components of adjusted gross income (AGI)--the actual income base of the individual income tax--which rose more rapidly than taxable personal income. Capital gains realizations, which are not included in either GDP or taxable personal income, account for a large part of the growth in AGI * (Capital gains account for a large part of the AGI growth.) Between 1994 and 1998, realizations of capital gains nearly tripled, with most of that increase occurring before the cut in tax rates for them in 1997. Taxes on capital gains accounted for roughly 30 percent of the growth of those liabilities relative to the growth of GDP from 1994 to 1998.

Other components of AGI that are not part of taxable personal income or GDP also rose more rapidly than both of those measures--especially retirement income from distributions from 401(k) plans and individual retirement accounts and from taxable Social Security benefits. The growth of the retirement and nonretirement components together accounted for about 6 percent of the increase in liabilities relative to the growth of GDP from 1994 to 1998.

The most significant source of the growth of income taxes relative to GDP was the increase in the effective tax rate. In tax years 1995 to 1998, increases in the effective rate (on income other than capital gains) accounted for more than 40 percent of the growth of liabilities in excess of the growth of GDP. * (Increased tax rates accounts for 40% of the revenue growth.) Increases in real income for taxpayers generally placed more income into higher tax brackets. That phenomenon alone accounted for more than half of the increase in income tax liabilities relative to GDP that resulted from the rise in the effective tax rate * ( real income increases account for more than 50% of the increased tax liabilities.) The remainder was due to income growth concentrated at the top of the income distribution, which raised the effective tax rate by increasing the proportion of income taxed at the highest rates. Even though no income group was subjected to higher statutory tax rates, a larger share of income accrued to taxpayers with the highest tax rates. (See Figure 3-4.)

Although the proximate causes of the surge in individual income tax receipts can be identified by examining tax filings, the underlying causes are more difficult to discern. * (CBO is acknowledging they may not completely understand what occurred.) In particular, it is difficult to isolate the role of the extraordinary rise in the stock market. The potential role of the stock market in boosting individual income taxes, and in generating receipts from other tax sources, is discussed in more detail below. * (So what role did the stock market play? It is explained further below.)

Revenues in 2000

After three years in which revenues exceeded one-year-ahead projections by substantial amounts, CBO's January 1999 revenue projection was largely on target. But in fiscal year 2000, revenues again exceeded CBO's projection by a substantial amount. In January 2000, CBO estimated that 2000 revenues would total $1,945 billion. However, the end-of-year figure was $2,025 billion, or $80 billion more. * (CBO does not understand the phenomena. If so, the projections would have reflected the actual.) Individual income taxes accounted for three-quarters of the difference (see Table 3-4). About half of the $60 billion underestimate of individual income taxes stemmed from higher-than-expected withholding. * (This appears to be W2 earnings.) The other half was from nonwithheld receipts, largely due to the return of the "April surprise" of unexpected final payments in the spring of 2000.

Table 3-4. Actual Revenues in Fiscal Year 2000, by Source, Compared with CBO's January 2000 Projections (In billions of dollars)
Source				Actual 2000 Revenues	CBO's January 2000 Projections	Difference
Individual Income Taxes
	Withheld			780	749	31
	Nonwithheld			358	331	27
	Refunds			-134	-135	1
		Subtotal		1,004	945	60
Corporate Income Taxes				207	189	18
Social Insurance Taxes				653	653	0
Excise Taxes				69	68	1
Other Revenue Sources				92	90	2
			Total	2,025	1,945	80
SOURCE: Congressional Budget Office.

Fiscal year 2000 individual income tax receipts jumped 14 percent over their level in fiscal year 1999--not only a substantial increase over the 6.1 percent of the previous year, but more than in any year in the 1990s. As a result, individual income tax receipts exceeded $1 trillion for the first time and reached a new peak as a percentage of GDP, exceeding 10 percent for the first time (see Table 3-5).

* Historical high individual tax receipts occurred in 2000. The CBO did not anticipate the rise, therefore, the CBO needs to explain the cause of the rise.

Table 3-5. CBO's Projections of Individual Tax Receipts and the Tax Base (By fiscal year)
		Actual 2000	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
Individual Income Tax Receipts
	In billions of dollars	1,004	1,076	1,125	1,176	1,230	1,289	1,354	1,424	1,500	1,583	1,675	1,774
	As a percentage of GDP	10.2	10.4	10.3	10.2	10.2	10.2	10.2	10.2	10.3	10.3	10.4	10.5
	Annual growth rate	14.2	7.1	4.6	4.6	4.6	4.8	5.0	5.2	5.3	5.5	5.8	5.9
Taxable Personal Income
	In billions of dollars	6,952	7,314	7,684	8,066	8,428	8,800	9,193	9,610	10,036	10,478	10,948	11,440
	As a percentage of GDP	70.7	70.9	70.6	70.3	69.9	69.5	69.2	69.0	68.7	68.3	68.0	67.6
	Annual growth rate	6.7	5.2	5.1	5.0	4.5	4.4	4.5	4.5	4.4	4.4	4.5	4.5
Individual Receipts as a Percentage of Taxable Personal Income		14.4	14.7	14.6	14.6	14.6	14.7	14.7	14.8	14.9	15.1	15.3	15.5
SOURCE: Congressional Budget Office.
NOTE: The tax base in this table reflects income as measured by the national income and product accounts rather than as reported on tax returns.

Capital gains realizations are notoriously difficult to predict. * (CBO is acknowledging the difficulty in predicting Capital Gains. Earlier in the revenue section the CBO stated the affects of Capital Gains were discounted in the out years. If it is notoriously difficult to predict capital gains, how were they discounted in the out years?) They constitute a relatively small percentage of tax receipts, however, which mutes their role in generating large errors in revenue projections (see Table 3-6). The January 2000 estimate of realizations in tax year 1999, which are important for fiscal year 2000 receipts because much of the resulting tax is paid with the subsequent filing of tax returns, was $500 billion, compared with actual realizations of about $555 billion.

Table 3-6. Actual and Projected Capital Gains (In billions of dollars)
	Realizations		Liabilities		Receipts^a		Receipts as a Percentage of Total Individual Income Tax Receipts
	Level (CY)	Percentage Change	Level (CY)	Percentage Change	Level (FY)	Percentage Change
1990	124	-20	28	-21	32	-14	7
1991	112	-10	25	-11	27	-17	6
1992	127	14	29	16	27	1	6
1993	152	20	36	25	32	20	6
1994	153	0	36	0	36	12	7
1995	180	18	44	22	40	10	7
1996	261	45	66	50	54	36	8
1997	365	40	79	19	72	33	10
1998	455	25	89	12	84	16	10
1999	555	22	109	22	98	17	11
2000	652	18	129	19	118	20	12
2001	652	0	129	0	129	9	12
2002	619	-5	121	-6	125	-3	11
2003	593	-4	116	-5	119	-5	10
2004	574	-3	111	-4	114	-4	9
2005	561	-2	108	-3	110	-3	9
2006	553	-1	106	-2	107	-2	8
2007	551	0	106	-1	106	-1	7
2008	554	0	106	0	106	0	7
2009	560	1	107	1	106	1	7
2010	571	2	109	2	108	1	6
2011	586	2	111	2	110	2	6
SOURCES: Congressional Budget Office; Department of the Treasury.
NOTE: CY denotes data on a calendar year basis, and FY denotes data on a fiscal year basis. Realizations represent net positive long-term gains. Data on realizations and liabilities after 1998 and data on receipts for all years are projected by CBO.
a. Receipts approximate the timing of the payments of liabilities during fiscal years.

Expected Pattern of Future Receipts

The growth of individual income tax receipts is expected to slow substantially in 2001, to 7.1 percent. That increase still exceeds the growth of GDP, so in 2001 individual income tax receipts as a percentage of GDP are projected to reach a new peak, 10.4 percent (see Table 3-5). * (CBO is projecting a higher percentage of taxes to GDP without citing a tax change.) Growth is then expected to slow further to 4.6 percent for three years and then increase each year through the end of the projection period, approaching 6 percent in 2011. So in that year, receipts as a share of GDP are projected to surpass previous highs, reaching 10.5 percent. * (CBO is projecting a record high of individual taxes to GDP in 2011, the most difficult year to project.)

A cooling of the economy is partly responsible for the slower growth at the beginning of the projection period: according to CBO's economic forecast, the growth of GDP is expected to slow from 7.3 percent in 2000 to an average of 5.2 percent over the next four years. But other, tax-specific factors also affect the path of individual tax receipts, namely, the four factors described above that explain the rapid growth of receipts during the 1995-1998 period: taxable personal income relative to GDP, capital gains realizations, taxable retirement income and other components of AGI that are not taxable personal income, and the effective tax rate.

In CBO's 2001-2011 economic projections, taxable personal income decreases as a share of GDP, which tends to slow the growth of receipts and further reduce their share of GDP over time. Much of that decrease in income, however, is in the more lightly taxed interest and dividend components of income rather than in wages and salaries. Consequently, the decline of taxable personal income as a share of GDP only slightly lowers the ratio of total receipts to GDP over the period of 2001 to 2011. * (CBO is projecting individuals will be able to maintain their earning levels. See schedule ??? to evaluate the assumption.)

The components of AGI fare differently in the projections. Capital gains realizations gradually resume their historical relation to GDP * (“gradually resume their historic relation…” Look at the NASDAQ graphs to determine how gradual the return was.) (with due allowance given to the effect of lower capital gains tax rates on taxpayers' willingness to realize gains), slowing the growth of receipts and reducing their share of GDP. As a result, receipts are about $120 billion lower in 2011 than they would have been if they maintained the same share of GDP as in 2000.

Other components of AGI, especially retirement income, become more important, raising the growth of individual income tax receipts slightly and slowly increasing their share of GDP over time. The growth of retirement income adds roughly $30 billion to receipts in 2011 relative to what they would have been with a constant receipts-to-GDP ratio.

The effective tax rate rises as a consequence of higher incomes. * (CBO is projecting higher incomes.) Because the alternative minimum tax is not indexed for inflation, higher nominal incomes subject more taxpayers to it. In addition, even though the regular income tax is indexed for inflation, real growth in incomes causes more people to be taxed at higher marginal rates because of the progressive rate structure. Those two factors tend to boost the growth of receipts and cause the receipts-to-GDP ratio to rise over time. The effects of the AMT raise receipts in 2011 by about $30 billion relative to what they would have been if the receipts-to-GDP ratio remained constant. (Those receipts include the additional receipts from disallowing child and education tax credits against the AMT after 2001.) The effects of real growth on the regular income tax raise 2011 receipts by approximately $75 billion relative to what they would have been if the receipts-to-GDP ratio remained constant. Although the rapid income growth among high-income taxpayers is not expected to further increase the effective tax rate beyond 2001, those taxpayers are expected to maintain the shares of income they gained during the recent economic boom. * (CBO is basing the projection on high-income individuals being able to maintain their recent gains.) As a result of that distributional change, CBO expects that the growth of receipts will slow and the receipts-to-GDP ratio will level off.

Together, the four tax-specific factors will cause the growth of individual receipts to slow and the receipts-to-GDP ratio to decline at first and then rise again. Initially, the pattern of lower capital gains realizations relative to GDP and slower growth of taxable personal income dominates and causes the receipts-to-GDP ratio to fall. Slowly, however, the other effects--the growth of taxable retirement income and the higher effective tax rate resulting from real income growth--cause the ratio to rise after 2005 so that it achieves a new postwar peak by the final year of the projection.

Clearly, the future course of most of these factors is very uncertain. * (CBO offers a significant qualifier on all of the above assumptions.) The implications of different courses for the effective tax rate and economic growth for the budget surplus are discussed in Chapter 5.

Corporate Income Taxes

In recent years, corporate income tax receipts have grown more rapidly than the overall economy. From 1995 to 1998, corporate income tax receipts as a percentage of GDP grew to levels not achieved since 1980. That performance was largely driven by very strong growth in corporate profits. In 1999, corporate income tax receipts as a percentage of GDP slipped as profit growth slowed. But in 2000, receipts as a share of GDP rebounded as profits grew strongly again.

CBO projects that from 2001 to 2011, corporate income tax receipts will no longer grow more rapidly than the economy, and over the next couple of years, they will grow little, if at all (see Table 3-7). Receipts rise very modestly in 2001, mainly because of the lagged effects of the strong profit growth recorded in 2000 * (CBO expects corporate taxes for 2001 and 2002 to be equivalent to 2000. Actual receipts were over $50 billion less.), and remain about the same in 2002. Corporate receipts begin to grow again in 2003 and continue to grow through 2011. As a percentage of GDP, they fall from 2.1 percent in 2000 and 2001 to 2.0 percent in 2002 through 2004 and 1.9 percent in 2005 and remain at that level thereafter.

Table 3-7. CBO's Projections of Corporate Income Tax Receipts and the Tax Base (By fiscal year)
		Actual 2000	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
Corporate Income Tax Receipts
	In billions of dollars	207	215	217	226	236	246	255	264	276	289	303	319
	As a percentage of GDP	2.1	2.1	2.0	2.0	2.0	1.9	1.9	1.9	1.9	1.9	1.9	1.9
	Annual growth rate	12.2	3.8	0.7	4.3	4.5	4.2	3.6	3.6	4.4	4.6	5.1	5.1
Corporate Book Profits
	In billions of dollars	920	929	940	965	1,007	1,043	1,081	1,119	1,174	1,231	1,296	1,369
	As a percentage of GDP	9.4	9.0	8.6	8.4	8.4	8.2	8.1	8.0	8.0	8.0	8.0	8.1
	Annual growth rate	16.3	1.0	1.2	2.7	4.4	3.6	3.7	3.5	4.9	4.9	5.3	5.6
Taxable Corporate Profits
	In billions of dollars	741	753	769	791	826	855	886	915	959	1,004	1,056	1,115
	As a percentage of GDP	7.5	7.3	7.1	6.9	6.9	6.8	6.7	6.6	6.6	6.5	6.6	6.6
	Annual growth rate	13.8	1.6	2.1	2.9	4.4	3.5	3.6	3.4	4.8	4.7	5.2	5.5
Corporate Receipts as a Percentage of Taxable Profits		28.0	28.6	28.2	28.6	28.6	28.8	28.8	28.9	28.8	28.7	28.7	28.6
SOURCE: Congressional Budget Office.
NOTE: The tax base in this table reflects income as measured by the national income and product accounts rather than as reported on tax returns.

The projection of corporate income tax receipts is nearly $400 billion more over the period of 2001 to 2010 than CBO's July projection. More than $300 billion of that increase is due to the change in the economic forecast. * (CBO is projecting higher corporate revenues based on improving economy, in spite of the noted recent slowing.) About $90 billion of it is due to technical revisions stemming from higher-than-expected corporate tax collections since July.

Projections of corporate income tax receipts are always subject to a great deal of uncertainty * (CBO notes the “great deal of uncertainty” associated with corporate tax receipts), although their relatively small size dampens the effect of that uncertainty on projections of total revenues. Much of the uncertainty stems from the fluctuation of corporate profits. Profits are essentially the residual income in an economy--what remains for the owners of firms after all of the other productive inputs have been compensated. As a result, profits tend to vary much more over time than do other sources of taxable income, making them difficult to project. * (Another CBO qualifier)

Uncertainty also arises from unexpected movements in the average tax rate (total corporate receipts as a percentage of total taxable profits). Those unexpected movements have been greatest following major changes in corporate tax law, such as occurred in 1986.⁽²⁾ Over much of the period since then, the average tax rate has been relatively stable, so CBO's projection error has typically resulted from profits that grew at rates different from those anticipated.

The slow growth of corporate income tax receipts in CBO's projection is the result of projected slow growth in taxable profits. A factor responsible for part of the slow growth of profits over the next several years is the projected behavior of book depreciation (the allowance for depreciation that firms are permitted for tax purposes). Investment in assets with short depreciable lives for tax purposes has risen sharply in recent years and is expected to rise strongly in 2001 and 2002 and then to slow. Thus, in 2001 and 2002, depreciation for tax purposes is expected to grow rapidly, followed by a gradual moderation in its growth. (The behavior of tax depreciation is the biggest reason that CBO's projections of book profits, which are close to the income measure on which taxes are collected, differ from the commonly used corporate economic profits that appear in the NIPAs as part of GDP.)

CBO makes several adjustments to book profits to produce an even better approximation of the corporate tax base, called "taxable corporate profits." First, CBO's measure excludes corporate profits from foreign subsidiaries of U.S. firms. Taxes on those profits are largely deferred under the corporate income tax until the profits are repatriated to the U.S. parent corporation, and even then they typically are not taxed because of a credit for foreign taxes paid on that income. Second, CBO's measure excludes profits of S corporations, which are usually smaller firms that qualify for taxation as partnerships. As such, their profits are considered to flow through automatically to the shareholders and are taxed as individual rather than corporate income. Other adjustments include subtracting corporate income taxes paid to state and local governments and the profits of the Federal Reserve System, and adding capital gains realized by corporations.

Book and taxable profits follow a very similar pattern over the projection period, growing at average annual rates of 3.7 percent and 3.8 percent, respectively. Differences occur in some years, but they are minor. CBO projects that through 2002, profits will remain relatively stable in dollar magnitude and therefore decline as a share of GDP. In 2003, profits are projected to start growing noticeably, although more slowly than GDP through 2007. Beyond 2007, profits will remain a relatively stable share of GDP. Receipts follow that pattern, so the average tax rate, defined as corporate receipts as a percentage of taxable profits, varies within a relatively narrow band of 28 percent to 29 percent over the projection period.

Social Insurance Taxes

Social insurance taxes follow roughly the same path as wages and salaries (see Table 3-8). The largest components are Social Security (Old-Age, Survivors, and Disability Insurance, or OASDI) taxes and Medicare (Hospital Insurance, or HI) taxes (see Table 3-9). They are calculated as a percentage of covered wages, the former up to a taxable maximum that is indexed to wage growth over time. Consequently, OASDI and HI taxes tend to remain stable as a proportion of income as long as covered wages are a stable share of GDP and the distribution of income from wages remains relatively stable. That relative stability is reflected in CBO's projection of social insurance tax receipts, which are expected to remain nearly flat at 6.6 percent of GDP between 2001 and 2011. As a share of wages and salaries, CBO projects that those receipts will drop by 0.1 percentage point to 13.8 percent in 2001 and then will decline only very slowly thereafter, to 13.7 percent through 2011. Since the July report, CBO's projection of social insurance receipts has increased by about $130 billion over 2001 to 2010. That increase is due almost entirely to CBO's revised economic forecast.

Table 3-8. CBO's Projections of Social Insurance Tax Receipts and Tax Base (By fiscal year)
		Actual 2000	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
Social Insurance Tax Receipts
	In billions of dollars	653	686	725	762	797	840	879	921	963	1,010	1,059	1,110
	As a percentage of GDP	6.6	6.6	6.7	6.6	6.6	6.6	6.6	6.6	6.6	6.6	6.6	6.6
	Annual growth rate	6.7	5.1	5.7	5.1	4.6	5.4	4.7	4.7	4.6	4.9	4.8	4.8
Wages and Salaries
	In billions of dollars	4,696	4,965	5,246	5,535	5,813	6,097	6,392	6,702	7,027	7,368	7,733	8,118
	As a percentage of GDP	47.8	48.1	48.2	48.2	48.2	48.2	48.1	48.1	48.1	48.0	48.0	48.0
	Annual growth rate	6.7	5.7	5.7	5.5	5.0	4.9	4.8	4.8	4.9	4.8	5.0	5.0
Social Insurance Receipts as a Percentage of Wages and Salaries		13.9	13.8	13.8	13.8	13.7	13.8	13.8	13.7	13.7	13.7	13.7	13.7
SOURCE: Congressional Budget Office.
NOTE: The tax base in this table reflects income as measured by the national income and product accounts rather than as reported on tax returns.

* See actual schedule.

Table 3-9. CBO's Projections of Social Insurance Tax Receipts, by Category (By fiscal year, in billions of dollars)
		Actual 2000	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
Social Security		481	504	532	561	589	620	649	680	712	746	782	819
Medicare		136	146	155	163	171	180	189	198	208	218	229	240
Unemployment Insurance		28	27	29	30	29	31	32	34	34	37	40	43
Railroad Retirement		4	4	5	5	5	5	5	5	5	5	5	5
Other Retirement		5	4	4	4	4	4	4	4	4	4	3	3
	Total	653	686	725	762	797	840	879	921	963	1,010	1,059	1,110
SOURCE: Congressional Budget Office.

Projected social insurance taxes drop as a fraction of wages in 2001 largely because the Treasury Department adjusted its 2000 tabulation of Social Security receipts to reflect previous misestimates, and CBO expects no similar adjustment in 2001. When OASDI and HI taxes are withheld from paychecks and remitted to the Treasury, they are indistinguishable from the individual income tax withholding that is remitted at the same time. The social insurance portions of the payments are estimated and assigned to the respective trust funds on the basis of Treasury's projections. As an accounting of the payments becomes available in the following years, the trust funds are adjusted to make up for any shortfall or excess in the estimates. As a result, lump-sum adjustments of social insurance tax receipts (with offsetting adjustments in individual income tax receipts) may occur in years other than those in which the payments were received and the liabilities incurred. In 2000, such an adjustment increased social insurance receipts by about $3 billion (an increase in OASDI taxes of $4 billion and a reduction in HI taxes of $1 billion). By their nature, these adjustments are unpredictable. Consequently, CBO makes no comparable or offsetting adjustments for 2001 or any other year in the projection period. Hence, social insurance taxes fall slightly as a percentage of wages in 2001 and are unaffected thereafter.

The very slow decline in social insurance receipts as a fraction of wages and salaries after 2001 is driven largely by revenues associated with Social Security and federal retirement programs. Revenues from Social Security retirement programs as a share of wages will fall slightly over the projection period as the portion of wages subject to Social Security taxes continues to decline gradually. Revenues from federal retirement programs--most of the "other retirement" category--will also decline slightly as federal workers under the old Civil Service Retirement System (CSRS), which has higher contribution rates, retire.

The projected level of receipts from the unemployment insurance program (including both the state and federal components of the unemployment tax system) fluctuates somewhat between 2001 and 2011. The recent extended period of high employment has caused benefit outlays to decline generally in recent years and thereby has permitted states to lower their contributions. For this reason, receipts in 2001 are projected to decline slightly. In 2003, according to CBO's projection, the Federal Unemployment Tax Act trust fund will reach its statutory cap, causing the federal government to transfer additional revenues to the states, permitting the states to further lower their unemployment tax rates and causing unemployment insurance receipts to decline the next year. Beyond 2004, however, unemployment insurance receipts will gradually increase, at a rate slightly faster than the increase in wages. CBO projects the unemployment rate to gradually increase through 2009, which causes benefit outlays, and the receipts that finance those outlays, to increase faster than wages.

Excise Taxes and Other Sources of Revenue

Excise taxes are expected to continue their long-term decline as a percentage of GDP, falling from their share of 0.7 percent in fiscal year 2000 to 0.6 percent toward the end of the projection period. Most excise taxes--those representing about 80 percent of total excise tax receipts--are levied per unit of good or per transaction, rather than as a percentage of value. Thus, although excise receipts grow with real output, they do not rise with inflation and therefore do not grow as fast as nominal GDP. CBO's current projection of excise taxes is changed little from that of July.

Nearly all excise taxes fall into five major categories: highway, airport, telephone, alcohol, and tobacco taxes. Almost half of all excise tax receipts are for the Highway Trust Fund, primarily from gasoline and diesel taxes (see Table 3-10). Most airport and telephone taxes are levied on a percentage basis, so they grow faster than other excise taxes. A small hike in tobacco taxes enacted in 1997 will increase the level of receipts in 2002. However, the projection of tobacco tax receipts also reflects the drop in tobacco consumption that is expected to result from the higher tobacco prices caused by the industry's settlements with the states. The net effect, CBO believes, is that tobacco receipts will be stable after 2003.

Table 3-10. CBO's Projections of Excise Tax Receipts, by Category (By fiscal year, in billions of dollars)
		Actual 2000	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
Highway		35	36	37	38	39	40	41	43	44	45	46	47
Airport		10	10	11	12	13	13	14	15	16	16	17	18
Telephone		6	6	6	7	7	8	8	8	9	9	10	11
Alcohol		8	8	8	8	9	9	9	9	9	9	9	10
Tobacco		7	7	8	8	8	8	8	8	8	8	8	8
All Other		3	3	3	3	3	3	3	3	3	3	3	3
	Total	69	71	74	76	78	81	83	86	88	91	94	97
SOURCE: Congressional Budget Office.

Smaller amounts of revenue come from estate and gift taxes, customs duties, and numerous miscellaneous sources (see Table 3-11). Estate and gift tax receipts have tended to grow more rapidly than income because the unified credit for the estate and gift tax, which effectively exempts some assets from the tax, is not indexed for inflation. (The annual exclusion for gifts is indexed for inflation, but the $10,000 maximum annual exclusion will not change until the cumulative inflation since 1997 is at least 10 percent.) By 2006, however, a higher unified credit enacted in the Taxpayer Relief Act of 1997 will be phased in, more than offsetting the absence of indexing and tending to reduce receipts relative to GDP. At the same time, however, the aging of the population will tend to increase estate tax receipts. These effects combine to cause estate and gift taxes as a share of GDP to decline slightly until 2006 and then slowly rise again through the end of the projection period.

Table 3-11. CBO's Projections of Other Sources of Revenue (By fiscal year, in billions of dollars)
	Actual 2000	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011
Estate and Gift	29	30	32	34	35	36	37	39	43	46	48	52
Customs Duties	20	21	23	24	25	26	27	27	28	29	30	31
Miscellaneous