By Kyle Pomerleau
The Congressional Budget Office (CBO) recently published its monthly budget review for September, now estimating a spike in federal tax receipts for the 2021 fiscal year. According to CBO, individual income tax receipts will climb by $443 billion (27.5 percent), and corporate income tax receipts will climb by $158 billion (74.8 percent). Overall, federal revenue is estimated to increase by 18.3 percent between 2020 and 2021, the largest one-year jump in 44 years, and will hit 17.8 percent of GDP, which is the highest since 2015.
CBO stated that this increase in receipts is primarily due to the strong economy in 2021. Some analysts have asked whether this is a “revenue miracle” and suggested that the higher revenue is in part due to the design of the Tax Cuts and Jobs Act. Others have suggested that the higher corporate tax collections call into question the administration’s argument that taxes on corporations need to go up.
Higher federal revenue in 2021 is good news to the extent it reflects a recovering economy, but it’s not clear whether revenue will remain this elevated. Some of the increase in revenue this year may reflect a temporary re-timing of income and expenses in expectation of income tax increases.
Democratic lawmakers are currently discussing legislation that would increase both individual and corporate income taxes. While the details are not final, lawmakers have proposed several tax increases including raising the top individual income tax rate from 37 percent to 39.6 percent, raising the top capital gains tax rate from 23.8 percent to as high as 43.4 percent, subjecting more pass-through business income to the 3.8 percent net investment income tax, and enacting a 3 percent surtax on taxpayers with adjusted gross income over $5 million. Democratic lawmakers have also proposed raising the corporate income tax rate from 21 percent to between 25 percent and 28 percent.
The expectation of impending tax increases creates an incentive for taxpayers to realize income this year instead of next year. For example, a taxpayer that owns stock would rather realize any gains this year when the top capital gains tax rate is 23.8 percent (20 percent plus the 3.8 percent net investment income tax) instead of next year when the rate could be higher. (This is why lawmakers have proposed a retroactive date for the capital gains tax rate increase). Similarly, a corporation has an incentive to book sales this year while the corporate income tax rate is 21 percent or delay expenses until next year when the rate may be higher.
There is good evidence that taxpayers engage in this behavior when there is an impending tax increase. Research on capital gains realization in response to tax increases finds a very large short-term response to higher tax rates. More recently, economists from the Joint Committee on Taxation found that corporations delayed income into 2018 and accelerated deductions to2017 in response to the sharp reduction in the corporate income tax rate from 35 percent to 21 percent in 2018.
Revenue growth is certainly good news as it reflects a recovering economy. However, some of the revenue growth could be temporary as taxpayers adjust income and expenses to avoid expected tax increases.