Federal Income Tax Revenue Volatility Since 1966

Abstract

Over the past two decades, the United States federal income tax revenue has shown periods of increased volatility. Throughout the 1990s the growth rate of individual income taxes was between 5 and 10 percent, it has swung between H12 and +12 percent from 2000 to 2006. Meanwhile wage income has been relatively stable during this period while capital income annual growth has swung from H20 to +50 percent between 2000 and 2006. Looking deeper into the income composition of taxable sources, we find that tax revenue has increased its dependence on volatile capital gains income, due in part to an increasing dependence on highHincome taxpayers. In the decade ending 1976, capital and business income represented about 17.1 percent of gross income, including about 3.1 percent for capital gains and losses. While the share of capital and business incomes have been relatively stable over time, the share of net capital gains or losses has increased to about 5.8 percent of gross income, on average the decade ending 2006, an almost twofold compared to four decades ago. Using a database on individual tax files from 1966 to 2006 from the Internal Revenue Service Public Use Files, we estimate the sources of tax revenue volatility over time and by income groups. We find strong evidence that since 1966, the growth rate of tax revenue has become increasingly dependent on the growth rate of capital income, while its dependence on wage income has decreased. Before 1986, both capital income growth and wage income growth were negatively related with income tax growth, suggesting a smoothing effect of taxation. However, after 1986, capital income growth has been positively related to income tax revenue growth, and this positive relationship has increased more than tenfold in 20 years. We also find that this increased dependence of tax revenue growth on capital income is essentially related to top income earners. The results show evidence that capital income growth and tax revenue growth almost continuously increased from the bottom to the top quintile.