Federal Government Revenue Sources

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.

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

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

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.

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.

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.

Figure 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.

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.

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.

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.

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.

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.

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

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.

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.

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

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.

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

Source: Bureau of Economic Analysis^1,2