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Federal Government Revenue Sources

Federal Government Revenue Sources

In 1861 the Union government enacted the first federal income tax. Any guess as to what they used the money for? It was to finance the Civil War. A few years after the war ended, the tax was repealed. Not until the Sixteenth Amendment to the U.S. Constitution was ratified in 1913 did the country have a permanent income tax.

What was the biggest federal government revenue source until then? What is the biggest federal government revenue source now? What are other federal government revenue sources? Read on to find the answers to these questions and much more!

Types of government revenue

Let's get started by talking about the types of federal government revenue sources. First, there are taxes. There are three types of taxes: proportional, progressive, and regressive.

A proportional tax taxes everyone at the same rate, regardless of income.

An example of this type of tax is the tax on corporate dividends.

A progressive tax taxes people with higher income at a higher rate.

An example of this type of tax is the individual income tax.

A regressive tax tends to hit people on the lower end of the income scale the hardest.

An example of this type of tax is the sales tax.

Since lower-income people tend to spend more of their income on items that are taxed, like food and clothing, the share of their income paid as tax also tends to be higher than for higher-income people.

Now, among taxes, there are income taxes and non-income taxes. Income taxes include individual income taxes, social insurance taxes (payroll taxes for Social Security and Medicare), and corporate income taxes.

Non-income taxes include excise taxes, estate taxes, and gift taxes.

The federal government can also generate revenue from asset sales, transfer receipts, customs duties, and fees.

To learn more about the different types of taxes, read our explanation of Types of Taxes!

Federal government's primary source of revenue

After the Civil War and up until 1913, the federal government's primary source of revenue was customs duties, which were levied on goods that were brought into the U.S. from abroad.

Customs duties are levied on many products, large and small, from automobiles and mineral shipments to liquor and art. However, these duties bring in only a small share of overall federal government revenue compared to the days before the introduction of the individual income tax, which is now the federal government's primary source of revenue.

Customs duties are taxes that are levied on goods that are brought into the U.S. from abroad.

The largest source of revenue for the federal government

Let us now take a look at the largest source of revenue for the federal government, individual income taxes, compared to other sources of revenue.

In 2020, the U.S. federal government collected $3.7 trillion in total revenue.1

As you can see in Figure 1 below, 55.8% of that came from taxes, of which a whopping 45.5% came from individual income taxes! The other 10.3% came from corporate income taxes, excise taxes, and customs duties.1 The next largest revenue source was contributions to social insurance, better known as payroll taxes, or FICA, which accounted for 39.2% of revenue. Asset income came next at 3.3% of revenue, while transfer receipts from individuals and businesses, and other smaller sources, accounted for the remaining 1.7%. So, at almost half of all revenue, individual income taxes are heavily relied upon to fund the U.S. federal government.

Federal Government Revenue Sources U.S. Federal Government Total Revenue 2020 StudySmarterFigure 1. U.S. Federal Government Total Revenue 2020, StudySmarter Originals. Source: Bureau of Economic Analysis1

U.S. federal government revenue sources

Let's now take a look at federal government revenue sources in a little more detail.

Individual income taxes are deducted from paychecks by employers and collected by the Internal Revenue Service (IRS). In addition, the tax code is indexed to prevent people from moving into a higher tax bracket and paying more taxes due to cost of living increases in their salaries to compensate for inflation.

Under FICA - the Federal Insurance Contributions Act - taxes are equally levied on employers and employees to fund Social Security and Medicare. These taxes are also known as payroll taxes. While income is only taxed up to a certain threshold to pay for Social Security, there is a flat tax rate and no threshold for Medicare.

FICA is deducted from almost everyone's paycheck. It stands for the Federal Insurance Contributions Act, under which taxes are deducted to pay fund Social Security and Medicare.

Corporate income taxes are taxes on the profits of companies. They are reported on the company's income statement. However, when they are paid varies. Depending on their tax situation, some companies pay their taxes in advance, while others pay them later. In addition, corporate taxes reported on the income statement don't always match the taxes reported to the IRS, but this issue is beyond the scope of this article.

Corporate tax is a tax on a company's profit.

Excise taxes are taxes on the manufacture or sale of goods. These taxes tend to be regressive (hurting low-income families more) because they tend to buy these items more frequently than higher-income families.

Excise taxes are taxes on the manufacture or sale of goods.

Estate taxes are taxes on the transfer of property after the property owner passes away. They are generally only paid by the very wealthy because the minimum value of an estate required to pay these taxes is in the millions of dollars.

Estate taxes are taxes on the transfer of property after the property owner passes away.

Gift taxes are taxes on the transfer of money or wealth, generally from one generation to the next. This tax was established to prevent people from passing on parts of their estate to their children before they die, thereby bypassing the estate tax.

Gift taxes are taxes on the transfer of money or wealth, generally from one generation to the next.

Customs duties are taxes on goods brought into the U.S. from abroad. This was the largest federal government revenue source before the implementation of the income tax. In 2020 they accounted for just 1.9% of total federal government revenue.1

Miscellaneous fees are generally user fees for things like entering national parks or the fees ranchers pay to allow their livestock to graze on federally owned land.

Government Borrowing

While borrowing does generate funds for the federal government, it is not considered revenue because the government eventually has to pay it back. When federal spending is greater than federal revenue, which is almost always the case these days, the federal government borrows money from investors by selling bonds to cover the difference. The federal government then pays back the original amount, called the principal, along with interest over a specified period of time. In 2020, the U.S. federal government spent $6.9 trillion but only raised $3.7 trillion in revenue, meaning the remaining $3.2 trillion had to be covered by borrowing. In other words, almost half of the money the federal government spent was borrowed!1

Examples of sources of federal and state government revenue

Examples of sources of federal government revenue include individual income taxes, payroll taxes, corporate income taxes, asset income, excise taxes, estate taxes, gift taxes, customs duties, and transfer receipts from individuals and businesses.

These same sources of federal revenue are also seen at the state level, but in different percentages and with different compositions. As you can see in Figure 2 below, taxes accounted for 62.7% of state and local government revenue in 2020, slightly higher than at the federal level. However, whereas individual income taxes accounted for 45.5% of all federal government revenue, they only accounted for 16.7% of state and local government revenue.2 The remaining 46% of taxes were comprised of property taxes, sales taxes, excise taxes, other taxes, and corporate income taxes, in order of largest to smallest. In fact, not only were individual income taxes at the state and local level less than at the federal level, they were even less than state and local property taxes.

After taxes, the next biggest source of state and local government revenue was transfer receipts, which accounted for 33% of revenue, the vast majority of which came from federal grants-in-aid, which are transfers from the federal government to state and local governments for education, infrastructure, social programs and such. As a matter of fact, while taxes were the largest source of state and local government revenue by category, the single largest source of revenue was grants-in-aid.2

Transfer receipts are transfers from the federal government, businesses, individuals, and the rest of the world to state governments to fund state programs and projects.

Grants-in-aid are transfers specifically from the federal government to state governments to fund state programs and projects.

Asset income accounted for 3.1% of revenue, while contributions to social insurance, or payroll taxes, only accounted for a tiny 1.3% of revenue, as can be seen in Figure 2 below.

Asset income is income generated from the sale of assets the government owns.

Thus, while taxes and asset income are pretty much equal at the federal level compared to the state and local level, transfer receipts and contributions to social insurance are essentially flipped in comparison. The federal government relies much more heavily on contributions to social insurance, while state and local governments rely much more heavily on transfer receipts.

Federal Government Revenue Sources U.S. State and Local Government Total Revenue 2020 StudySmarterFigure 2. U.S. State and Local Government Total Revenue 2020, StudySmarter Originals. Source: Bureau of Economic Analysis2

To learn more about state and local revenue sources, check out our explanations - State Government Revenue Sources and Local Government Revenue Sources!

To help you better understand the differences between federal and state, and local government revenue sources, have a look at Table 1 below. Again, the biggest differences between federal and state, and local government revenue sources are between contributions from social insurance and transfer receipts. These rows are highlighted for your convenience.

Note: The sub-category percentages do not add up to the category percentages because there are other much smaller taxes that were not included as they do not add to this discussion.

CategorySub-categoryPercent of Federal Government RevenuePercent of State and Local Government Revenue
Taxes55.8%62.7%
Individual Income Taxes45.6%16.7%
Property TaxesNA19.9%
Sales TaxesNA14.5%
Corporate Income Taxes5.2%2.3%
Contrib. From Soc. Ins.39.2%1.3%
Asset Income3.3%3.1%
Transfer Receipts1.7%33.0%
Grants-in-AidNA28.4%

Table 1. Differences Between Federal and State and Local Government Revenue Sources.

Source: Bureau of Economic Analysis1,2

Federal Government Revenue Sources - Key takeaways

  • There are several types of federal government revenue sources, including income taxes, non-income taxes, asset sales, transfer receipts, customs duties, and fees.
  • The federal government's primary source of revenue is individual income taxes. Almost half of all federal government revenue comes from individual income taxes.
  • Federal government revenue sources include individual income taxes, payroll taxes, corporate income taxes, excise taxes, estate taxes, gift taxes, customs duties, and fees. The government can raise funds by borrowing, but it is not considered revenue.
  • While taxes and asset income account for roughly the same share of federal government revenue compared to state and local government revenue, the federal government relies much more heavily on contributions to social insurance, while state and local governments rely much more heavily on transfer receipts.

References

  1. Bureau of Economic Analysis, Table 3.2 https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey
  2. Bureau of Economic Analysis, Table 3.3 https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey

Frequently Asked Questions about Federal Government Revenue Sources

The federal government's largest source of revenue is individual income taxes.

Federal government revenue sources include individual income taxes, payroll taxes, corporate income taxes, excise taxes, estate taxes, gift taxes, customs duties, and fees. The government can raise funds by borrowing, but it is not considered revenue.

State and local government revenue sources include individual income taxes, property taxes, sales taxes, excise taxes, other taxes, corporate income taxes, transfer receipts, asset income, and payroll taxes.

The non-tax sources of federal government revenues include asset income and miscellaneous fees.

The sources that produce the most revenue for the federal government are individual income taxes and payroll taxes.

Another source of funds the federal government has is proceeds from bond sales. However, this is not considered revenue because the government eventually has to pay the money back to investors.

Final Federal Government Revenue Sources Quiz

Question

In what year was the first federal income tax enacted?

Show answer

Answer

1861

Show question

Question

What did the first federal income tax help to finance?

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Answer

The Civil War

Show question

Question

In what year was the income tax made permanent?

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Answer

1861

Show question

Question

The three types of taxes are...

Show answer

Answer

proportional

Show question

Question

Non-income taxes include which of the following?

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Answer

Excise taxes

Show question

Question

The federal government's primary source of revenue is...

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Answer

Individual income taxes

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Question

Which of the following are federal government revenue sources?

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Answer

Individual income taxes

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Question

Payroll taxes are used to fund...

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Answer

Social Security

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Question

A tax on the manufacture or sale of goods is known as...

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Answer

an excise tax

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Question

Estate taxes are paid by everyone.

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Answer

False

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Question

The _____ tax was established to prevent people from bypassing the _____ tax.

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Answer

Gift/estate

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Question

These days, customs duties account for a very _____ portion of federal government revenues.

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Answer

small

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Question

Proceeds from bond sales are considered revenue.

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Answer

False

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Question

In 2020, almost half of the money the U.S. federal government spent was borrowed.

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Answer

True

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Question

Taxes and asset income are pretty much equal at the federal level compared to the state and local level.

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Answer

True

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Question

At which level are payroll taxes more relied upon for revenue?

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Answer

Federal

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Question

At which level are transfer receipts more relied upon for revenue?

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Answer

State and local

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Question

If you were on the city council and you wanted to generate more revenue, you would most likely lobby to increase which tax rate?

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Answer

Property tax rate

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Question

If you were on the federal budget committee on wanted to generate revenue, you would least likely lobby to increase which tax rate?

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Answer

Excise tax rate

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Question

The sales tax is _____ because it hits low-income people the hardest.

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Answer

Regressive

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