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Overall US Tax Rate Edged Up In 2004

by Mike Godfrey,, Washington

10 January 2007

Compared with its rate in 2003, the overall effective tax rate rose by 0.2 percentage points in 2004 to 20.0% from 19.8% due to increases in both the effective individual income and corporate income taxes, according to a study by the Congressional Budget Office.

The CBO report shows that tax law changed little from 2003 to 2004, as most provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 were fully in effect in 2003.

Other than adjustments for inflation, the following provisions were all identical in 2003 and 2004: the schedule of tax rates and tax brackets, the size of the child tax credit, the exemption amount under the alternative minimum tax, and the marriage penalty relief provisions.

However, several tax provisions did change. The reduced tax rates on income from capital gains and dividends were in effect for all of 2004, but only for the latter part of 2003. A new provision allowed taxpayers who paid more in state sales tax than in state income tax to deduct sales tax from their income. The amount of the child tax credit that could be claimed by taxpayers with no income tax liability rose in 2004, from 10% to 15% of wage income above a threshold. And, beginning in 2004, taxpayers could deduct from their income any contributions to health savings accounts.

Nonetheless, the effective individual income tax rate rose by 0.3 percentage points in 2004. Part of that increase came from real bracket creep — the tendency of effective income tax rates to rise as income grows faster than inflation, causing more income to be taxed in higher brackets. An upward shift in the income distribution also contributed to the effective tax rate increase.

Two factors mitigated that rise in effective tax rates. The changes in tax law relating to income from dividends and capital gains, sales tax deductibility, the child tax credit, and health savings accounts all served to lower individual income taxes for a given level of income, pushing down the effective tax rate. In addition, income from capital gains and dividends, which faces lower tax rates than most other income, grew more rapidly than other forms of income, driving down the effective rate.

The effective corporate income tax rate also rose by 0.3% points, reflecting rapid growth in corporate profits and even stronger growth in the taxes owed on those profits.

In contrast, the effective social insurance tax rate fell by 0.3 percentage points, partially offsetting the increases in the other tax rates. Wage income, the base for that tax, grew more slowly than nonwage income, lowering the effective tax rate. The share of wages earned above the Social Security taxable maximum also increased, further pushing down the effective payroll tax rate.

CBO’s analysis of effective tax rates draws information on income from two primary sources: the Internal Revenue Service's Statistics of Income bulletin, which reports much of the information that taxpayers provide on their individual income tax returns; and the March supplement to the Bureau of the Census’s Current Population Survey.

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