Americans paid out an estimated 14.7% of personal income in 2022 in what the US Bureau of Economic Analysis calls personal current taxes (mainly federal, state and local income taxes), an all-time high. But don’t worry, the percentage will be lower in 2023.
This record-setting income tax burden, and the sharp increase since 2020 that brought it to this level, was not due to new tax legislation taking effect during this period. It also wasn’t really expected — the Congressional Budget Office greatly underestimated how much income tax revenue would flow into federal coffers last year. It seems to have been the result of a pandemic asset-price boom interacting with inflation, a progressive tax code and, in a few states, the aftereffects of tax legislation enacted by Congress in 2017. The first two effects are fading, and the BEA’s monthly estimates of personal current taxes show that rates have already retraced more than half their pandemic increase since last summer.
As noted in the charts, personal current taxes include some non-income-tax charges such as personal property taxes and motor-vehicle license fees, but over the past decade those have added up to less than 2% of the total (the exact 2022 breakdown hasn’t been released yet). The White House Office of Management and Budget’s annual estimates also show personal income tax revenue hitting a record as a s How 2022 Became A Record Year For US Income Taxes hare of gross domestic product in the 2022 fiscal year, which ended in September — 10.5% compared with a previous record of 9.9% set in fiscal 2000 — and Treasury Department data show a similar recent decline in monthly personal income tax receipts. I’m using the BEA’s personal current taxes estimates here because they include state and local taxes and can simply be divided by personal income to give Americans’ effective tax rate.
There are, of course, other levies besides income taxes, and by the BEA’s accounting 2022 total government receipts didn’t quite break the 2000 record as a percentage of GDP (29.9% compared with 30.6%), as lower GDP shares coming from government social insurance contributions (aka Social Security and Medicare taxes), corporate income taxes and other sources such as interest and deposit insurance premiums offset the higher personal current taxes share. (Taxes on production and imports were pretty much a wash.)
But back to those income taxes. The main reason they rose so much and so high over the past couple of years is that asset prices rose so much and so high, and people sold them for big profits. The CBO estimates that the percentage of total federal personal income tax receipts coming from taxes on capital gains was higher than ever before in fiscal 2021 and 2022.
Long-term capital gains are taxed at lower rates than other income (15% for those with overall incomes of up to about $500,000 a year, 20% above that), so in itself a higher capital gains share shouldn’t necessarily drive income tax rates up sharply. But almost three-quarters of capital gains in the 2020 tax year (the most recent for which such data are available from the Internal Revenue Service) went to taxpayers with adjusted gross incomes of $500,000 or more, meaning that most long-term gains were probably taxed at the higher 20% rate and most short-term gains at the 37% top income tax rate. An increase in capital gains also implies increases in other forms of income that rise with asset prices — employee stock-option exercises, Wall Street bonuses, real estate commissions, etc. — that are also taxed at rates of up to 37%.
So, again, an asset-price boom (or bubble, if you prefer) and its interaction with a tax code that taxes higher incomes at higher rates explain most of the increase in effective income tax rates in 2021 and 2022. The declines since the beginning of 2022 in stock and bond prices and the drop since mid-year in real estate prices have thus been bringing tax rates back down, with a bit of a lag because taxes on capital gains and some other big chunks of income aren’t always paid immediately.
The increase in capital gains receipts accounted for less of the overall rise in income tax receipts in fiscal 2022 than in 2021 (13% compared with 27%), though, so something else must have been going on to drive the 2022 effective tax rate so much higher. That something was probably mostly bracket creep because of inflation.
Bracket creep is when inflation pushes people into higher tax brackets even as their real (that is, inflation-adjusted) incomes stagnate or fall. In the 1960s and 1970s, it was a significant source of government revenue, with inflation driving effective income tax rates ever higher even as Congress passed multiple tax cuts, until the 1981 federal tax cut law finally indexed the brackets to inflation. Still, the indexing process is inevitably backward looking, with the 3.1% bracket increases for 2022 determined in November 2021 by dividing the average chained consumer price index from September 2020 through August 2021 by the average from September 2019 through August 2020. When consumer prices subsequently jumped 10% from August 2021 through the end of 2022, a fair amount of that year’s income was thus bumped temporarily into higher brackets. What’s more, 15 states and the District of Columbia don’t adjust their income tax brackets for inflation, and several more don’t adjust standard deductions or personal exemptions, meaning they still impose permanent bracket creep on their residents.
One of these states is New York, which also plays a role in the last part of my explanation for why income tax rates were so high last year. The 2017 Tax Cuts and Jobs Act cut income tax rates for almost all groups of Americans, but there was an important exception: very high earners in high-tax states, who were no longer able to deduct more than $10,000 in state and local income and property taxes from federal taxable income. As a result, according to the IRS, the top 1% of earners in New York, California and Connecticut paid a higher percentage of adjusted gross income in federal income taxes in 2018, 2019 and 2020 than they did in 2017, before the TCJA took effect. Those in the District of Columbia paid more in 2018 and 2020 but not 2019, and the top 1% of taxpayers in every other state faced lower tax rates in every subsequent year than they did in 2017.
In 2020, the top 1% of earners in New York, California and Connecticut paid 11.9% of all federal income taxes, so the higher rates they face are of some national significance. We’ll have to wait and see (the 2021 data will be out in October) if amid the asset-price-fueled income gains of 2021 and 2022 they were significant enough to drive income tax rates higher nationally.
In the meantime, we can expect more declines in effective tax rates and probably federal revenue.
Amid tech-boom fueled budget surpluses early in the 2000s, President George Bush and Congress did not take into account the temporary factors driving income tax rates and revenue upward and approved a series of tax cuts that returned the US to chronic budget deficits. Now there don’t appear to be any federal tax cuts on the table, but spending rose so much during the pandemic that even big increases in tax revenue made only a modest dent in the deficit — and in the past few months real spending has started rising again while revenue declines. One of these days we may need a permanent tax increase instead of a fluky temporary one.
This article was provided by Bloomberg News.