Overview of the Federal Tax System

Publication Date: June 2006

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance

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Abstract:

The individual income tax is the major source of federal revenue, followed closely by Social Security taxes. As a revenue source, the corporate income tax is a distant third. Federal estate and gift and excise taxes play only minor roles as revenue sources.

In 2005, individual income taxes accounted for 43% of total federal revenue. Social security taxes accounted for 37%. Corporate income taxes accounted for 13%; excise taxes accounted for 3%; and estate and gift, customs, and miscellaneous taxes accounted for the remaining 4% of total revenue. Over time, corporate income tax has become much less important as a revenue source while social security taxes have become much more important.

In 2000, total receipts were 20.9% of gross domestic output (GDP), which represented a post World War II high. By 2004, federal receipts had fallen to 16.3% of GDP, the lowest level since 1959. Most of this reduction was attributable to legislated tax cuts. (Receipts rose in 2005 to 17.5% of GDP.) Taxes (including all levels of government) in the United States are low compared to those in most other developed countries.

There are four individual income tax filing categories: married filing jointly, married filing separately, head of household, and single individual. The individual income tax base is wages, salaries, tips, income from investments, and business income. The base is reduced by certain adjustments, such as contributions to traditional IRAs, producing adjusted gross income (AGI). Standard or itemized deductions and personal exemptions reduce AGI to taxable income, which is taxed at graduated rates of 10%, 15%, 25%, 28%, 33%, and 35%. Preliminary tax liability is then reduced by tax credits to arrive at a taxpayer's final income tax liability.

Corporate taxable income is subject to a set of graduated rates: 15%, 25%, 34%, and 35%, but most income is taxed at the top rate. The base is approximately earnings from equity investments.

Social Security and Medicare tax rates are, respectively, 12.4% and 2.9% (half paid by the employer and half by the employee). In 2006, Social Security taxes are levied on the first $94,200 of wages, with the wage cap adjusted annually for increases in average wages in the economy. Medicare taxes are assessed against all wage income.

The major federal excise taxes are levied on transportation fuels, alcohol, tobacco, telephones, and domestic air transport.

This report will be updated on enactment of major changes in the federal tax system.