Why were revenues higher that expected in 1997?

U.S. government tax receipts in fiscal year 1997 turned out to be $72 billion higher than the $1,507 billion that the Congressional Budget Office (CBO) estimated in January 1997 (see Exhibit 1). The strength of those revenues - which took most observers by surprise - is explained mainly by unexpectedly strong growth in individual income tax receipts. Those receipts had been projected to rise by 3 percent, a somewhat lower rate than the growth in taxable personal income (that is, wages and salaries plus income from nonwage sources other than capital gains). Instead, those receipts rose by more than 12 percent, in part because personal income grew more rapidly than expected, but mainly because of unusually high realizations of capital gains and because a growing share of income was earned by people at the top of the income ladder, who are taxed at higher rates. Those two factors caused individual income tax receipts to grow twice as fast as personal income. As a result, CBO's estimate of such receipts fell $61 billion short of the actual amount.

Corporate income tax receipts also exceeded expectations in 1997 - although by a smaller amount, $3 billion - consistent with stronger-than-expected corporate profits. Legislation reinstating some excise taxes in 1997 was responsible for another $3 billion of the revenue increase. And because wages were somewhat higher than [TABULAR DATA FOR EXHIBIT 1 OMITTED] expected, higher receipts from payroll taxes for social insurance programs contributed an additional $5 billion.

The $61 billion underestimate of individual income tax receipts cannot be thoroughly explained until tax returns for 1997 have been filed and the data processed - sometime late in 1998. Nevertheless, a considerable amount of information has become available in the past few months that allows much of the story to be told.

CBO's largest single underestimate occurred in the area of nonwithheld income taxes: Final payments were about $25 billion higher than CBO had projected - accounting for 40 percent of the underestimate of individual income tax receipts. According to preliminary data from the Internal Revenue Service based on 1996 tax returns, about $20 billion of that $25 billion represented taxes on capital gains realizations and $5 billion reflected a timing shift, as taxpayers waited until the following April to pay a surprisingly large fraction of their 1996 tax liabilities. The other $14 billion of the underestimate of...