Economics of Taxation
Throughout history, every organized society
had some form of government. In free
societies, the goals of government have been
to protect individual freedoms and to promote
the well-being of society as a whole.
To meet their expenses, government need
income, called "revenue," which it raises
through taxes. In our country, governments
levy several different types of taxes on
individuals and businesses. The Federal
Government relies mainly on income taxes for its revenue.
State governments depend on both income and
sales taxes. Most county
and city governments use property taxes to raise their
revenue.
Our American economy is based on the free
enterprise system. Consumers are free to
decide how to spend or invest their time and
money. The goal of producers is to make
profits by satisfying consumer demand. Open
competition among producers usually results
in their providing the best quality of goods
or services at the lowest possible prices.
The free enterprise system does not
produce all the services needed by society.
Some services are more efficiently provided
when government agencies plan and administer
them. Two good examples are national defense
and state or local police protection.
Everyone benefits from these services, and
the most practical way to pay for them is
through taxes, instead of a system of service
fees. Other examples are the management of
our natural resources, such as our water
supply or publicly-owned land, and the
construction of hospitals or highways. Taxes
are collected to pay for planning these
services and to finance construction or
maintenance. Revenue is also collected
through user fees, such as at the entrances
to national parks or at toll booths on
highways and bridges.
Society benefits from a safe and healthy
environment. In the free enterprise system,
however, there is often little incentive for
businesses to pay the extra cost for
maintaining this kind of environment.
Therefore government imposes regulations on
producers such as auto manufacturers, who
must install air pollution controls. These
controls often add costs to the price of new
cars. There are also regulations to control
such things as the use of billboards and
signs along highways. Other regulations
control reclaiming land after strip mining,
dumping industrial waste into streams and
rivers, and noise pollution at airports.
The free enterprise system is based on
competition among businesses. With
competition, only the most efficient
businesses survive. To ensure that a degree
of competition exists, the Federal Government
enforces strict "antitrust" laws to prevent
anyone from gaining monopoly control over a
market.
Some services, known as "natural
monopolies," are more efficiently provided
when there is competition. The best-known
examples are the utility companies, which
provide water, natural gas, and electricity
for home and business use. Since there is no
competition, government agencies carefully
regulate the services, prices, and profits of
the utility companies.
The free enterprise system assumes that
consumers are knowledgeable about the quality
or safety of what they buy. However, in our
modern society, it is often impossible for
consumers to make informed choices. For
public protection, government agencies at the
Federal, State, and local levels issue and
enforce regulations. There are regulations to
cover the quality and safety of such things
as home construction, cars, and electrical
appliances. There are also regulations for
financial services provided by banks,
insurance companies, and stock brokers.
Another important form of consumer protection
is the use of licenses to prevent unqualified
people from working in certain fields, such
as medicine or the building trades.
Our children receive their education
mainly at public expense. City and county
governments have the primary responsibility
for elementary and secondary education. Most
states support colleges and universities. The
Federal Government supports education through
grants to states for elementary, secondary,
and vocational education. Federal grants used
for conducting research are an important
source of money for colleges and
universities.
Since the 1930s, the Federal Government
has been providing income or services, often
called a "safety net," for those in need.
Major programs include health services for
the elderly and financial aid for the
disabled and unemployed. Other major programs
include financial aid to families with
dependent children, and social services for
low income individuals and families.
Governments pay for these services through
revenue obtained by taxing three economic
bases: income, consumption and wealth. The
Federal Government taxes income as its main
source of revenue. State governments use
taxes on income and consumption, while local
governments rely almost entirely on taxing
property and wealth.
The earnings of both individuals and
corporations are subject to income taxes.
Most of the Federal Government's revenue
comes from income taxes. The personal income
tax produces about five times as much revenue
as the corporate income tax.
Not all income tax taxed in the same way.
For example, taxpayers owning stock in a
corporation and then selling it at a gain or
loss must report it on a special schedule.
This item and any other gains or losses get
calculated separately before they get added
to other income. By comparison, the interest
they earn on money in a regular savings
account gets included with wages, salaries
and other "ordinary" income. There are also
many types of tax-exempt and tax-deferred
savings plans available that impact on
people's taxes.
Payroll taxes are an important source of
revenue for the Federal Government. Employers
are responsible for paying these taxes, which
include social security insurance and
unemployment compensation. Employees also pay
into the social security program through
money withheld from their paychecks. Some
state governments also use payroll taxes to
pay for the state's unemployment compensation
programs.
Over the years, the amount paid in social
security taxes has greatly increased. This is
because there are fewer workers paying into
the system for each retired person now
receiving benefits. Today, some workers pay
more social security tax than income tax.
The most important taxes on consumption are
sales and excise taxes. Sales taxes usually
get paid on such things as cars, clothing and
movie tickets. Sales taxes are an important
source of revenue for most states and some
large cities and counties. The tax rate
varies from state to state, and the list of
taxable goods or services also varies from
one state to the next.
Excise taxes, sometimes called "luxury
taxes," are used by both state and Federal
Governments. Examples of items subject to
Federal excise taxes are heavy tires, fishing
equipment, airplane tickets, gasoline, beer
and liquor, firearms, and cigarettes.
The objective of excise taxation is to
place the burden of paying the tax on the
consumer. A good example of this use of
excise taxes is the gasoline excise tax.
Governments use the revenue from this tax to
build and maintain highways, bridges, and
mass transit systems. Only people who
purchase gasoline -- who use the highways --
pay the tax.
Some items get taxed to discourage their
use. This applies to excise taxes on alcohol
and tobacco. Excise taxes are also used
during a war or national emergency. By
raising the cost of scarce items, the
government can reduce the demand for these
items.
The property tax is local government's main
source of revenue. Most localities tax
private homes, land, and business property
based on the property's value. Usually, the
taxes get paid monthly along with the
mortgage payment. The one who holds the
mortgage, such as a bank, holds the money in
an "escrow" account. Payments then get made
for the property owner.
Some state and local governments also
impose taxes on the value of certain types of
"personal" property. Examples of personal
property often taxed are cars, boats,
recreational vehicles, and livestock.
Property taxes account for more than
three-fourths of the revenue raised through
taxes on wealth. Other taxes imposed on
wealth include inheritance, estate, and gift
taxes.
A basic principle underlying the income tax
laws of the United States is that people
should be taxed according to their "ability
to pay." Taxpayers with the same total income
may not have the same ability to pay. Those
with high medical bills, mortgage interest
payments, or other allowable expenses can
subtract these amounts as "itemized
deductions" to reduce their taxable incomes.
Similarly, taxpayers may subtract a certain
amount on their tax returns for each
allowable "exemption." By lowering one's
taxable income, these exemptions and
deductions support the basic principle of
taxing according to ability to pay.
Those with high taxable incomes pay a
larger percentage of their income in taxes.
This percentage is the "tax rate." Since
those with higher taxable incomes pay a
higher percentage, the Federal income tax is
a "progressive" tax.
Sales and excise taxes, by comparison, are
considered "regressive." Since the goods get
taxed at the same percentage, those with
lower incomes pay a larger percentage of
their income in sales and excise taxes.
Federal income taxes are collected on a
"pay-as-you-go" withholding system. Most
employers must withhold taxes from their
employees' paychecks and send the money for
deposit into the General Fund of the
Treasury. Self-employed individuals and
businesses must pay their taxes in regular
installments, known as estimated tax
payments. Paying taxes through withholding or
estimated taxes during the year helps reduce
the government's expense for borrowing money.
It also provides an easier method for
taxpayers to pay their taxes. To keep
collection costs down, the
expects all taxpayers to comply with the law
voluntarily. Most taxpayers figure out how
much tax they are supposed to pay and file
their income tax return by the date it is
due. Without this voluntary compliance, it
would cost the
a great deal more to collect the same amount
of revenue.
The Federal Government operates on a fiscal
year that begins on October 1 and ends on
September 30. Most of the Federal
Government's revenue comes from personal
income taxes. Other sources of revenue
include social security and other insurance
taxes and contributions, corporate income
taxes, excise taxes.
Federal receipts are spent on many
programs. Among the largest are social
security and Medicare. Another large portion
of Federal spending is for national defense,
and includes pensions for retired military
personnel and defense-related atomic energy
activities.
Another major government expenditure is
net interest, or interest payments on the
public debt less interest received by trust
funds and other interest the government
receives. The Federal Government borrows
money by selling
(bills, notes and bonds), , and other securities.
Income security programs, including
unemployment compensation, retirement and
disability programs, and benefits such as
food stamps and housing subsidies, also come
from Federal Government revenues. Also, the
Federal Government spends money on health
care, including assistance for the poor
through the Medicaid program, the training of
health care professionals, and medical
research activities.
Programs for education also get funded by
Federal revenues. These programs include
education, training and social services such
as grants to elementary, secondary, and
vocational schools and assistance to colleges
and universities. Also included in this
category are grants made to state for social
services programs.
Veterans and their dependents also receive
benefits from the Federal Government. This
included pensions, medical services,
education training, and life insurance
programs.
Transportation is another spending
category and includes grants to states and
local government for constructing highways,
mass transit systems, and airports. Also
included in this category are the costs of
operating the Coast Guard, regulation of the
airways, and assistance to railroads and
shipping.
There are many other Federal Government
services and activities, including protection
of natural resources, environmental
protection, and maintenance of recreation
areas and public lands. In addition, there is
assistance to foreign countries, disaster
relief and community and regional
development. Other government services are
energy research, development, and
conservation, and space exploration and other
scientific research. The Government must pay
for its administrative activities, along with
Federal law enforcement and Federal prisons,
payments to the Postal Service, aid to small
businesses, and mortgage financing insurance.
Finally, the Government provides funds for
crop subsidies, agricultural research, and
conservation of farmland.
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