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Federal personal income tax liabilities and payments: revised and updated estimates, 1984-86.

THIS article compares Federal personal income tax liabilities and payments for 1984-86 (table 1).' The liability series reflects final 1984-85 and preliminary 1986 data from Statistics of Income, Individual Income Tax Returns. The payment series, which appears in table 3.2 of the national income and product accounts (NIPA) tables, reflects estimates presented in the NIPA revisions released in July 1988.

In the NIPA's, personal income taxes are recorded on a payment basis-that is, at the time tax payments are made by individuals. For many types of analysis, personal income taxes on a liability basis-that is, at the time taxpayers earn their income and the tax liability is incurred-may be more appropriate than on a payment basis.

Differences between liabilities and payments

The payment series consists of three parts: Withheld taxes; declarations and final settlements, referred to as "nonwithheld" taxes; and refunds. Withheld taxes are those withheld at the income source. Declarations are estimated taxes paid on incomes not subject to withholding, and final settlements are additional taxes paid either at the time of filing tax returns when liabilities exceed payments or as result of audits. Refunds occur whenever payments exceed liabilities. Differences between the liability and payment series can occur in each of the three parts.

For taxes withheld from wages and salaries, differences arise for three reasons. First, taxes paid according to the withholding tables may result in overwithholding for some taxpayers because the tables are constructed under the assumption that taxpayers use the standard deduction in calculating their income tax liabilities. Overwithholding results unless taxpayers who itemize their deductions request additional exemptions for withholding purposes. Second, changes in withholding rates may not always coincide with changes in liabilities because tax law provisions usually are effective on January 1, but corresponding changes in withholding rates sometimes occur later. Third, graduated withholding rates, introduced in 1966, can result in changes in taxes withheld that are different from changes in liabilities if income or deductions change during the tax year.

Taxes withheld on some taxable incomes have no direct relationship to the corresponding liabilities, causing further differences. For interest, dividends, and certain other types of income, 20 percent is withheld if the recipient fails to furnish an accurate taxpayer identification number. (This withholding was initiated in 1984 as a compliance measure.) For pensions and annuities, withholding is optional.

For nonwithheld taxes on proprietors' income, capital gains, taxable social security benefits, and certain other types of taxable income, differences between liabilities and payments arise for four reasons. First, the last installment of quarterly estimated taxes and the final settlements are made in the tax year following the liability year. Second, the tax rate schedules used to compute quarterly estimated taxes do not always fully reflect changes in liabilities. Third, the proportion of the current year's liabilities that must be paid to avoid a penalty is less than 100 percent.2 Fourth, payments of nonwithheld taxes tend to be unrelated to changes in income. Thus, when income growth accelerates, liabilities tend to increase faster than payments.

For refunds, differences arise because the payment series records refunds as negative payments at the time they are made by the Treasury, mostly in the first and second quarters after the liability year. Thus, refunds are unrelated to current year's liabilities.

Differences for 1984-86

In 1984, liabilities exceed payments by $5.1 billion. First, the 1983 Social Security Amendments and the Railroad Retirement Solvency Act of 1983 increased liabilities by making portions of social security benefits and railroad retirement benefits taxable beginning in 1984, and most recipients of such benefits did not make estimated tax payments. The 1984 increase in liabilities resulted in increased payments in 1985, either in the form of larger final settlements or smaller refunds for recipients of such benefits. Second, because 1983 tax rate schedules for estimated taxes did not fully reflect the reduction in liabilities under the Economic Recovery Tax Act of 1981 (ERTA), quarterly estimated payments in 1983 were unusually large and the corresponding settlements in 1984 were unusually small. Third, income growth accelerated in 1984; taxable income increased by 10.1 percent, compared with 4.9 percent in 1983.

In 1985, liabilities are less than payments by $5.3 billion. Although the Tax Reform Act of 1984 (TRA) increased liabilities by delaying, reducing, or repealing certain tax reductions enacted by ERTA and scheduled to take effect in 1985, the increase was not enough to overcome large final payments arising &om underpayments of the 1984 liabilities.3 Both liabilities and payments were affected by the indexing provisions of ERTA and the corresponding cut in withholding rates, which went into effect in January 1985.

In the first and second quarters of 1985, liabilities and payments differ significantly. The differences resulted from problems in processing tax returns, which delayed the Treasury's mailing of refunds. Prior to 1985, the Treasury paid about 30 percent of refunds in the first quarter and about 60 percent in the second. In 1985, however, about 20 percent was paid in the first quarter and about 70 percent in the second. Because the payment series is net of refunds, the delay in refunds resulted in a large increase in payments in the first quarter and subsequent decline in payments in the second.

In 1986, liabilities exceed payments by $27.5 billion. This substantial difference was largely due to realized capital gains. The 1986 preliminary Statistics of Income tabulation shows that realized net capital gains less losses included in adjusted gross in 1986 were $136.3 billion, compared with $68.3 billion in 1985. This large increase in net capital gains reflected repeal of the preferential tax treatment of long-term capital gains by the Tax Reform Act of 1986. Under the act, capital gains are taxed at the same rates as ordinary income, effective in 1987, except that the top rate was limited to 28 percent in 1987. Under the previous law, long-term capital gains were taxed at 40 percent of the ordinary income tax rates, which put the top rate at 20 percent. Many tax payers, faced with the higher rates, accelerated realizations of capital gains into 1986-sharply increasing liabilities. (The quarterly liability series reflects these realizations beginning in the first quarter.) Because capital gains are not subject to withholding, the 1986 payments were not affected by the accelerated realizations. In 1987, final payments are expected to be large.
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Author:Park, Thae S.
Publication:Survey of Current Business
Date:Sep 1, 1988
Words:1061
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