Under current law, ordinary taxable income earned by most individuals through 2012 will be taxed at the following six statutory rates: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent. (Income from long-term capital gains, which is taxed under a separate schedule, is excluded from ordinary income. For tax years 2011 and 2012 only, dividends are also excluded from ordinary income because they are subject to a separate rate schedule for those years.) After 2012, those rates are scheduled to revert to the rates that were in effect before 2001: 15 percent, 28 percent, 31 percent, 36 percent, and 39.6 percent. The lower rates were originally enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 and were scheduled to expire at the end of 2010. They were extended for two years by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312).
Under the tax code, different tax rates apply at different levels of ordinary taxable income. (Taxable income generally is gross income minus allowable adjustments, exemptions, and deductions.) Tax brackets--the income ranges to which the different rates apply--vary depending on whether a taxpayer files singly or jointly. (See the table on page 140 for a list of the six tax brackets for both single and joint filers and the corresponding statutory tax rates.) In 2011, for example, a person filing singly with taxable income of $40,000 would pay a tax rate of 10 percent on the first $8,500 of taxable income, 15 percent on the next $26,000, and 25 percent on the remaining $5,500 of taxable income. The starting points for those income ranges are indexed to increase with inflation each year. Taxpayers who are subject to the alternative minimum tax (AMT) face statutory rates of 26 percent and 28 percent. (Federal tax liability is computed differently under the AMT than it is under the regular income tax because the former allows a more limited set of exemptions, deductions, and tax credits; taxpayers pay the higher of their regular tax or the AMT.)
Income from long-term capital gains is taxed under a separate rate schedule, with a maximum statutory rate of 15 percent; that rate will remain in effect through 2012 and then rise to 20 percent in ensuing years. Income from dividends is currently subject to the same rate schedule that applies to long-term capital gains; however, after 2012, dividends will be taxed as ordinary income.1
This option includes four alternative approaches for increasing statutory rates under the individual income tax. Those approaches are as follows:
Raising all statutory tax rates on ordinary income by 1 percentage point would increase revenues by a total of $208 billion from 2012 through 2016 and by $480 billion from 2012 through 2021. If this alternative was implemented, for example, the top rate of 35 percent that is scheduled to be in effect in 2012 under current law would increase to 36 percent; and the top rate of 39.6 percent that is scheduled to be in effect starting in 2013 would increase to 40.6 percent. Rates for the AMT would remain the same as they are under current law. Thus, the impact on revenues of raising all ordinary tax rates would diminish over time relative to the size of the economy because, under current law, a greater share of taxpayers would become subject to the AMT and therefore would not be affected by the increase in regular rates.
Raising AMT rates along with all of the regular tax rates by 1percentage point would increase revenues by $291 billion from 2012 through 2016 and by $702 billion over the 2012-2021 period. Unlike the first approach, this alternative would impose higher rates on all ordinary taxable income, regardless of whether those rates were applied according to the regular or AMT schedule. Consequently, the amount of additional revenues would not be greatly affected by the growing number of taxpayers subject to the AMT because those taxpayers would face higher statutory tax rates, too.
If, in addition to raising the ordinary and AMT rates, lawmakers boosted the separate tax rates on capital gains and dividends by 1 percentage point, federal revenues would increase by a total of $295 billion over the next five years and by $715 billion over the 2012-2021 period.
Alternatively, lawmakers could target specific individual income tax rates. For example, boosting only the top statutory rate on ordinary income by 1 percentage point would raise revenues by $30 billion from 2012 through 2016 and by $84 billion over the 10-year period. Because most people who are subject to the top rate in the ordinary schedule are not subject to the alternative minimum tax, the AMT would not significantly limit the effect of that increase in regular tax rates. Raising the rates for the top two or three brackets would generate more revenues.
As a way to boost revenues, an increase in tax rates would offer some administrative advantages over other types of tax increases because it would require only relatively minor changes to the current tax system. Rate hikes also would have drawbacks, however. Higher tax rates would reduce people's incentive to work and save. In addition, from taxable to nontaxable or tax-deferred forms. (Such a they would encourage taxpayers to shift income from shift might involve substituting tax-exempt bonds for taxable to nontaxable forms and to increase spending other investments or opting for more tax-free fringe bene- on tax-deductible items, such as home mortgage interest. fits instead of cash compensation.) However, the esti- In those ways, higher tax rates would cause economic mates do not incorporate potential changes in how much resources to be allocated less efficiently than they might people would work or save in response to higher statutory be otherwise. tax rates. Such changes are difficult to predict and would depend in part on whether the federal government used The estimates shown here reflect the assumption that tax-the added tax revenues to reduce deficits or to finance payers would respond to higher rates by shifting income increases in spending or cuts in other taxes.