Taxes and Government Spending
TAXES AND GOVERNMENT SPENDING
Governments are responsible for providing services that individuals cannot effectively provide for themselves, such as military defense, fire and police departments, roads, education, social services, and environmental protection. To generate the revenue necessary to provide these services, governments institute taxes based on income, consumption (sales taxes), and wealth (property and estate taxes). Taxes are broadly defined as being either direct or indirect. Direct taxes (for example, the federal income tax) are paid by the person on whom the tax is being levied. Indirect taxes are passed on from the responsible party to someone else. Examples of indirect taxes include business property taxes, gasoline taxes, and sales taxes, which are levied on businesses but passed on to consumers via increased prices.
When individuals with higher incomes pay a higher percentage of a tax, it is considered a "progressive" tax; when those with lower incomes pay a larger percentage of their income, a tax is considered "regressive." The federal income tax is an example of a progressive tax, because individuals with higher incomes are subject to higher tax rates. Sales and excise taxes are regressive, since the same tax applies to all consumers regardless of income, so less prosperous individuals pay a higher percentage of their incomes.
The most common taxes levied by federal, state, and local governments include the following:
- Income taxes—charged on wages, salaries, and tips
- Payroll taxes—social security insurance and unemployment compensation, which are paid by employers and withdrawn from payroll checks
- Property taxes—levied on the value of property owned, usually real estate
- Capital gains taxes—charged on the profit from the sale of an asset such as stock or real estate
- Corporate taxes—levied on the profits of a corporation
- Estate taxes—charged against the assets of a deceased person
- Excise taxes—collected at the time something is sold or when a good is imported
- Wealth taxes—levied on the value of assets rather than on the income they produce
The amount of tax an individual or family pays to the government, including their income, payroll, excise, and other taxes, is known as their tax burden. According to Isaac Shapiro in "Overall Federal Tax Burden on Most Families—Including Middle-Income Families—at Lowest Levels in More Than Two Decades" (Center on Budget and Policy Priorities, April 10, 2002), the median four-person family with two dependents paid 6.8% of its income in federal income tax in 2001, which was the lowest percentage since 1957.
Natwar M. Gandhi, the chief financial officer of the District of Columbia, estimated in Tax Rates and Tax Burdens: In the District of Columbia—A Nationwide Comparison (August 2004) that an American family of four with an income of $50,000 paid an average of 8.3% of its income in state and local taxes in 2003, including $1,561 in state or local income taxes, $1,843 in property taxes, $797 in sales taxes, and $247 in automobile taxes. At the $75,000 income level, American families paid an average of $6,832 in state and local taxes, or 9.1% of their income in 2003. According to Gandhi, Bridgeport, Connecticut, had the highest taxes of the fifty-one cities in the study. Families at the $50,000 income level living in Bridgeport paid 13% of their income ($7,501) in state and local taxes in 2003. For families in Bridgeport earning $75,000, the state and local tax burden increased to 17.7%, or $13,272.
Although Americans commonly complain about the amount of taxes they pay, the overall tax burden in the United States is generally lower than it is in other advanced economies. According to the Organisation for Economic Co-operation and Development (www.oecd.org), at the turn of the twenty-first century the tax burden as a percentage of the gross domestic product (GDP; the total value of all goods and services produced by an economy) in the United States was 29.6%, which compared favorably with such nations as the United Kingdom (37.4%), Canada (35.8%), France (45.3%), Germany (37.9%), and Sweden (54.2%), but was higher than Korea (26.1%) and Japan (27.1%). According to "How Competitive Is the U.S. Tax System?," a study issued by the Joint Economic Committee of the U.S. Congress in April 2004, the United States imposed the lowest taxes on the personal income of wealthy individuals during 2003 among eight leading industrial nations and was the only country without a national sales tax. (See Table 8.1.) However, when comparing tax rates in the United States to those in Australia, Canada, France, Germany, Italy, Japan, Spain, and the United Kingdom, the study reported that the U.S. corporate tax rate, which is 35% at its maximum, was among the highest, and the United States was the only country to tax corporate profits at both the corporate and the individual levels—that is, the corporation pays corporate taxes on its profits, and when the profits are distributed to shareholders as dividends, the shareholders also pay taxes on that income.
Even before there was a federal government, taxes were a significant issue for Americans. The Stamp Act of 1765 was the first tax imposed specifically on the American colonies by the British Parliament and was strongly resisted by the colonists, who maintained that only representative legislatures in each colony possessed the right to impose taxes. This view, that "taxation without representation" was tyranny, contributed to the opposition to British rule that led to the Revolutionary War (1775–1783). Of course, it was necessary for the newly independent colonies to establish taxes of their own. As Benjamin Franklin wrote, "in this world nothing can be said to be certain, except death and taxes" (November 13, 1789), and over the next two centuries a complex taxation code was developed at the federal, state, and local levels.
Taxes on Income
The federal income tax came into effect in 1913 with ratification of the Sixteenth Amendment to the Constitution: "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration." In the United States, tax rates are approved by Congress and signed into law by the president; the Internal Revenue Service (IRS), a bureau of the Department of Treasury, enforces the tax codes and collects tax payments, which are due each year on April 15. The IRS processed tax returns from 130.7 million individuals in 2003, as well as returns from 5.9 million corporations and 29.9 million employers.
individual income taxes. The percentage of an individual's income that he or she pays in federal tax is based on his or her income level, which determines the individual's "tax bracket." Tax brackets change as Congress modifies the tax codes, but individuals with higher incomes are always taxed at a higher rate than individuals with lower incomes. Taxpayers who are not claimed as dependents on someone else's tax return are allowed to take "personal exemptions," that is, an amount excluded from their taxable income. Table 8.2 shows personal exemptions and the lowest and highest tax bracket rates for individual income tax in the tax years 1913 through 2003. In 1913 income over $3,000 ($4,000 for married couples) but less than $20,000 was taxed at a rate of 1%. The highest tax bracket that year was 7%, paid on income exceeding $500,000. By the 1950s personal exemptions had been reduced to $600 for a single person and $1,200 for a married couple, with effective tax rates for the lowest bracket of about 20% on income under $4,000. (The effective tax rate is the percentage derived by dividing the actual tax paid by total taxable income.) Taxpayers in the highest bracket during the 1950s—in other words, those with the most income—paid approximately 90% on income above $400,000. By 2000 personal exemptions were $2,800 for individuals and $5,600 for married couples, with a rate of 15% on income below $43,850. At the turn of the twenty-first century, the highest tax bracket paid 39.6% on income over $288,350.
According to the IRS in Your Federal Income Tax: For Individuals, for the 2004 tax year a single person making less than $7,150 paid just 10% of his or her income, while a single person making more than $319,100 paid $92,592.50 plus 35% of every dollar earned over $319,100. These numbers, however, are not based on the total salary a person earns; rather, they are based on adjusted income levels. Through a variety of tax credits and deductions, individuals can lower the amount of income on which taxes are calculated, thereby lowering the amount of tax they pay.
corporate income taxes. The federal tax on corporate income has been in effect since 1909. Because corporations are owned, and individuals derive income from them, the potential exists for "double taxation," that is, the same income taxed twice, once as corporate income and, when the profits have been distributed to shareholders, again as individual income. To reduce the effects of double taxation, various credits and deductions have been
|Tax rates in large advanced economies, 2003|
|(2003 unless otherwise indicated)|
|Type of tax||Australia||Canada||France||Germany||Italy||Japan||Spain||UK||USA 2003||USA 2000|
|Corporate||30%||24.6–38.6%||34.33%,||27.9575%||34%||30%||35%||30%||35% fed. +||35% fed. +|
|Standard rate||fed. + prov.||territorial||0–12% state||0–9.99% state|
|Capital gains||Standard rate||Standard rate, 50% excluded||Standard rate||0%||Standard rate||Standard rate||Standard rate||Standard rate||Standard rate||Standard rate|
|Dividend tax||Standard rate||0%||0%||0%||Standard rate, 56.25% cred.||Standard rate, 50% ex.||Effectively 0%||0%||Standard rate||Standard rate|
|Personal||47% from||39–48.2%||49.58% from||47% from||45% from||50% natl. +||35.1–45%||40% from||35% fed. +||39.6% fed. +|
|Income tax, top rate||A$60,000||fed. + prov. fr. C$103,000||?47,131||?52,293||?70,000||local from ¥18 mn.||natl. + local from ?45,000||£30,500||0–11% state fr. US$311,950||0–9.3% state fr. $288,350|
|Payroll tax on employee||1.5%||4.95%, max. C$1,802 fed.||10%||13.65%, max. ?7,610||9.89% to ?80,391||0.7% no max. + 13.46%, ¥1.2mn. max.||6.35–6.4% to ?31,824||11% to £30,420, then 1%||fed. 1.45% no max. + 6.2% to US $87,000||fed. 1.45% no max. + 6.2% to US $76,200|
|Payroll tax on employer||0% federal, ~6% state||7.05%, max. C$2,621 fed.||4.25–13.6%||13.65%, max. ?7,610||23.81% to ?80,391||1.6% no max. + 13.46%, ¥1.2mn. max.||30.6–32.3% to ?31,824||12.8%||fed. 1.45% no max. + 6.2% to US$87,000||fed. 1.45% no max. + 6.2% to US$76,200|
|Sales or value added tax||10%||7% fed. + 0–10% prov||19.6%||16%||20% natl. + 4.5% local||5%||16%||17.5%||0% federal + 0–7.25% state||0% federal + 0–7% state|
|Interest tax||Income rate||Income rate||17.6%, ?15,000 ex.||Income rate, ?1,550 ex.||12.5%||20%||Income rate||Up to 40%||Income rate||Income rate|
|Dividend tax||Income rate||24.1–37.3% fed. + prov.||Income rate||Income rate, 50% excluded||12.5%||Income rate||Income rate||10%, 32.5% fr. £30,500||5–15%; double taxed||Income rate; double taxed|
|Long term capital gains||Income rate, 50% ex.||Income rate, 50% excluded||17.6%, ?15,000 ex.||0%||12.5%||10%||15%||Income rate, £7,900 ex.||5–15%||10–20%|
|Short term capital gains||Income rate||Income rate, 50% ex.||17.6%, ?15,000 ex.||Income rate, 50% ex.||27%||20%||Income rate||Income rate, £7,900 ex.||Income rate||Income rate|
|Retirement savings tax||15% to A$109,924*, then 30%||0%||0%||Income rate, 70% average excluded||12.5% on capital gains||0%||0%||0%||0%||0%|
|–limit on contribution||A$87,141||C$13,500||?24,000||?918||?5,165||¥180,000||?8,000–24,250||UK£3,600–36,720||US$3,000–3,500 (IRAs)||US$2,000 (IRAs)|
|Tax on retirement income||15% first A$1.12 mn. lifetime, then income rate||Income rate||Income rate||Income rate, sliding ex. (73% for 65-year old)||Income rate, 40% excluded||Favorable rates, up to ¥3.49mn ex.||Income rate on interest||Income rate, 25% excluded||Income rate||Income rate|
|Inheritance tax, top rates||0%||0%||5–60%, ?1,500 ex.||17–50%, ?1,100 ex.||0%, but other taxes, ?150,000 ex.||20–50%, ¥25mn. excluded||7.65–81.6%||40%, £242,000 excluded||18–49% fed., US $1.1mn. ex., + state||18-55% fed., US $675,000. ex., + state|
|Wealth tax||0%||0%||0.55–1.8%, ?720,000 ex.||0%||0%||0%||0.2–2.5%, ?08,182 house ex.||0%||0% federal 0–0.15% state||0% federal 0–0.15% state|
|Notes: *In taxable income. All the countries listed tax personal income on a worldwide basis. "Income rate" means that the rates of the income tax apply. Rates are for single filers and apply only to national taxes unless indicated. Abbreviations: cred. = credit; ex. = excluded; fed. = federal; fr. = from; max. = maximum; min. = minimum; mn. = million; natl. = national; prov. = provincial. Currency symbols: A$ = Australian dollar; C$ = Canadian dollar; ? = euro; £ = British pound; ¥ = Japanese yen.|
|source: "Table 1. Tax Rates in Large Advanced Economies (2003)," in How Competitive Is the U.S. Tax System? Joint Economic Committee, United States Congress, April 2004, http://www.house.gov/jec/tax/04-20-04.pdf (accessed March 12, 2005)|
|Personal exemptions and lowest and highest tax bracket rates for individual income tax, tax years 1913–2003|
|[Amounts are in dollars]|
|Tax rates for regular tax—|
|Personal exemptions||Lowest bracket||Highest bracket|
|Tax year||Single persons (1)||Married couples (2)||Dependents (3)||Tax rate (percent) (4)||Taxable income under—(5)||Tax rate (percent) (6)||Taxable income over—(7)|
enacted throughout the years to allow income to pass through a corporation without being taxed until it reaches the individual.
Table 8.3 lists corporation income tax brackets and rates from 1909 through 2002. The rates presented in the table are standard rates that do not take into account the credits and
|source: Adapted from "Table A. U.S. Individual Income Tax: Personal Exemptions and Lowest and Highest Bracket Tax Rates, and Tax Base for Regular Tax, Tax Years 1913–2003," in Statistics of Income Bulletin—Historical Tables and Appendix, Internal Revenue Service, Fall 2004, http://www.irs.gov/pub/irs-soi/03inta.xls (accessed March 9, 2005)|
depreciation schedules that reduce the amount of revenue subject to tax. After beginning with a modest 1% tax between 1910 and 1915, corporate tax rates for the highest income bracket hovered near the 50% level between the 1940s and 1970s before beginning a downward trend in the late 1980s. As of 2002, the lowest corporate income bracket had been taxed at the same level (15%) since 1983. For the highest bracket in 2002, a 35% tax was levied on income above $18,333,333.
social insurance taxes. Social insurance taxes (also known as "FICA taxes" in reference to the Federal Insurance Contributions Act that authorizes them) are collected from employers and employees and are used primarily to fund Social Security payments for retirees and disabled workers, as well as their survivors and dependents. In addition to Social Security, these taxes (which are sometimes referred to as "payroll taxes") are used to finance unemployment compensation and Medicare. Half of FICA is paid by wage earners and is deducted from their paychecks; the other half is paid directly by employers. In 2005 the tax withheld for Social Security amounted to 6.2% on the first $90,000 of income. This meant that the maximum Social Security tax withheld from an employee's paycheck for 2005 was $5,580. Medicare taxes were withheld at a rate of 1.45% with no annual maximum. Altogether in 2005, the employee and employer contributions for FICA taxes totaled 15.3%, which was the amount paid by self-employed individuals.
Payroll tax revenue is deposited into two accounts: the Old Age and Survivors Insurance (OASI) Trust Fund (which pays retirees and their survivors) and the Disability Insurance (DI) Trust Fund (which pays benefits to disabled workers). When more money is collected in taxes than is paid out to beneficiaries, the surplus funds are invested in Treasury securities, which earn interest and can be redeemed if needed. According to the 2005 Social Security Trustees Report (March 23, 2005), assets of the combined OASDI trust funds in 2004 totaled $1.7 trillion. By law the government is prohibited from spending surplus Social Security funds on other programs, in order to ensure that retirement money will be available for future retirees.
According to the Social Security Administration (SSA) in "Social Security Basic Facts" (March 23, 2005),
|Corporate income tax brackets and rates, 1909–20021|
|Year2||Taxable income brackets3||Rates (percent)|
|1909–1913 (February 28)||First $5,000||—|
|1913 (March 1)–1915||All taxable income||1.00|
|1916||All taxable income||2.00|
|19174||All taxable income||6.00|
|1932–1935||All taxable income||13.75|
|1936–19375, 6||First $2,000||8.00|
|Over $2,000, not over $15,000||11.00|
|Over $15,000, not over $40,000||13.00|
|1938–19395||Taxable income $25,000 or less:|
|Taxable income over $25,000||19.00|
|19405, 7||Taxable income $31,964.30 or less:|
|Taxable income over $31,964.30, not over $38,565.84:|
|Taxable income over $38,565.84||24.008|
|19415,7||Taxable income $38,461.54 or less:|
|Taxable income over $38,461.54||31.009|
|1942–19455, 7||Taxable income $50,000 or less:|
|Next $15,000||27.009, 10|
|Next $5,000||29.009, 10|
|Next $25,000||53.009, 10|
|Taxable income over $50,000||40.009, 10|
|1946–1949||Taxable income $50,000 or less:|
|Next $25,000||53.009, 10|
|Taxable income over $50,000||38.009, 10|
|Over $25,000||49.2016, 17|
|1The rates shown are the "standard" or "ordinary" rates, applying to all taxable corporate net income unless otherwise provided. However, there have always been numerous exceptions and special rates based on the type of corporation, the type of income, and other factors. In addition, there have been, at various times, additional taxes related to income that increased the statutory rates. When possible, these are noted in other footnotes to this table for the years for which they were effective. Credits, deductions, and other alterations in the definition of taxable income also effectively alter the tax rate, but these are too numerous and too frequent to include in a table such as this.|
|The most important types of corporations to which these rates have not always applied, or not applied as they did to other corporations, are: Section 501(c) and similar nonprofit corporations: Corporations not organized or operated for profit are generally exempt from the corporation income tax except, since 1950, on business income unrelated to their exempt purposes. Mutual and cooperative organizations: Most of these were treated as nonprofits in the early days of the income tax. Most have long since been made taxable as ordinary corporations, but there are still some exceptions. Credit unions and small mutual property insurance companies are exempt. Rural electrical and telephone cooperatives are exempt on income generated in transactions with their members. Farmers' cooperatives are not taxed on income distributed to their members. Insurance companies: Because of the nature of insurance, determining taxable income has often been a problem for the tax system. Insurance companies have been subjected to a number of different tax structures since 1921, including special rates and complete exemption of premium income. They are currently taxed at the same rates as other corporations on income calculated using reserve deductions (which other corporations are not allowed). Regulated investment companies (since 1936) and Real estate investment trusts (since 1961): These investment companies are not taxed on profits distributed to shareholders if they distribute substantially all of their incomes annually. S corporations: Since 1958, certain closely held corporations could elect to be taxed through their shareholders, as partnerships are, and not pay the corporate tax at all (except in special, unusual circumstances). Foreign corporations: Companies incorporated outside the U.S. are taxed on business income earned in the U.S. at the regular corporate rates, but may be taxed on investment income at special statutory or treaty rates. U.S. corporations with foreign-source income: The U.S. taxes the worldwide income of U.S. corporations; however, since 1918, taxes paid to foreign governments on foreignsource income can be credited against the U.S. tax otherwise due on that income. (Before 1918, the foreign taxes were allowed as a deduction against worldwide income.) U.S. possessions corporations: Since 1921, corporations earning most of their incomes in a U.S. possession were subject to reduced taxes. From 1921 to 1976, they were taxable only on U.S.-source income; since 1976, they have received a credit for manufacturing income earned in a possession (including Puerto Rico). The credit is now being phased out and is scheduled to end after 2005. Affiliated groups: Corporations that are closely affiliated through stock ownership have usually been allowed to consolidate their financial statements for tax purposes and file one return for the group, but there have always been restrictions and, sometimes, they have been charged an additional tax for the privilege. In 1932 and 1933, consolidated returns were subject to an additional tax of .75 percent. In 1934 and 1935, only railroad companies were allowed to file consolidated returns, and the additional tax was 1 percent. From 1936 to 1941, there was no additional tax, but the privilege was restricted to railroads and a few other companies. From 1942 to 1964, most domestic affiliated groups that met the stock ownership and other requirements could file consolidated returns, but the surtax on such a group was increased by 2 percentage points. The additional tax on consolidated returns was repealed, effective December 31, 1963.|
|The most important type of income to have received special rates was "long-term" capital gains. From 1942 through 1987, the tax rate was capped at a maximum rate lower than the highest corporate rate. (The rates are noted in footnotes to the table.) Although there is currently no special rate for corporations' capital gains, longterm capital gains are still treated separately from other income in the tax code.|
|During World War I, the Great Depression, World War II, and the Korean War, additional taxes were imposed on what were called "war profits" or "excess profits." These are noted in the table in footnotes to the applicable years.|
|In addition to taxes based on net income, there have been from time to time taxes based on accumulated earnings that were not distributed to shareholders, designed to limit tax avoidance at the individual stockholder level. Taxes on "undue" accumulations have been imposed (though seldom paid) since the inception of the income tax. These were supplemented, since 1934, by a "personal holding company" tax, equal to the highest individual income tax rate, on the undistributed earnings of closely held companies accumulating investment income. There was also a Depression-era tax on accumulated earnings (noted below).|
|In recent years, there have also been "minimum taxes" designed to supplement the regular taxes. These have the effect of a separate set of tax rates. These are noted in footnotes to the table.|
|2Calendar year unless otherwise noted. Taxpayers whose fiscal years spanned years with different rates were required to prorate the year's income between the two rate structures. Before 1933, the proration was based on the number of months in each year; after 1932, it was based on the number of days in each year.|
|3"Taxable income" is used here to mean the amount of income to which the rates shown were applied. The concept has had various names and various meanings over the years covered; so, brackets for one year are not necessarily comparable with those for another.|
|4An additional tax on "excess profits" and/or "war profits" was in effect from 1917 to 1922. It was allowed as a deduction in computing income tax.|
|5An additional "declared value" excess profits tax, based on profits in excess of a percentage of the value of corporate stock, was in effect from 1933 through 1945. It was a deduction for income tax purposes.|
|6An additional surtax ranging from 7 percent to 27 percent was imposed on undistributed profits.|
|7From June 1940 to the end of 1945, a tax on profits in excess of average prewar earnings was also imposed. It was taken into account, as either a deduction or a credit, for the income tax and the other excess profits tax.|
|8The rates for 1940 include extra "defense tax" rates that are integrated with the regular rates in later years.|
|9These rates are the sum of the "normal tax" rates and the "surtax" rates, which actually applied to slightly different definitions of taxable income.|
|10Beginning with tax year 1942, gains on the sale of assets held for more than 6 months (long-term capital gains) could be treated separately from other taxable income and taxed at a maximum rate of 25 percent.|
|11An excess profits tax was also in effect from July 1950 through calendar year 1953. The tax was 30 percent of an adjusted profits figure reduced by credits for the level of prewar profits. It was not offset against income tax, but the sum of income and excess profits taxes was capped at a given percentage of income (from 62 percent to 70 percent).|
|12These rates reflect a tax increase (for the Korean War), effective March 31, 1951. The maximum capital gains tax rate was also increased to 26 percent. From April 1, 1954, through calendar year 1969, the maximum tax rate on capital gains was 25 percent.|
|13From April 1, 1954, through calendar year 1969, the maximum tax rate on capital gains was 25 percent.|
|14From 1969 through 1986, corporations were also subject to an "add-on minimum tax" on certain "tax preference" items (such as percentage depletion, accelerated depreciation, etc.) above a certain amount. For tax years 1969 through 1976, the tax was 10 percent of tax preferences in excess of $30,000; after 1976, the tax was 15 percent of preferences in excess of the greater of $10,000 or regular income tax.|
|15Rates include the Vietnam War surcharge of 10 percent.|
|16Includes a 2.5-percent Vietnam War surcharge.|
|17The maximum tax rate on long-term capital gains was increased to 28 percent.|
|18The maximum tax rate on long-term capital gains was increased to 30 percent.|
|19The holding period for long-term capital gain treatment of assets was increased from 6 to 9 months in 1977 and 12 months in 1978. The rate remained at 30 percent.|
|20The maximum tax rate on long-term capital gains was 28 percent.|
|21Beginning in 1983, incorporated professional practices ("personal service corporations") have been taxed on all taxable income at the corporate tax rate applicable to the highest income bracket.|
|23The Tax Reform Act of 1986 (TRA86) established a new rate structure effective for tax year 1988 and made the rates for transition year 1987 an average of the pre-TRA rates for 1986 and the post-TRA rates for 1988. A new "alternative minimum tax" (AMT) replaced the add-on minimum tax, effective in 1987. It required a calculation of an alternative measure of taxable income that reduced or eliminated many tax preference items. The tax was 20 percent of the excess of this "alternative minimum taxable income" (AMTI) over $40,000. The $40,000 exemption was reduced by 25 percent of the excess of AMTI over $150,000. AMT in excess of regular tax could be carried over as a credit against regular tax in future years. In 1998, "small" corporations (generally, those with average gross receipts of less than $5 million) were exempted from the AMT.|
|24The maximum tax rate on capital gains was capped at 34 percent for 1987, which was to be the rate on the highest corporate tax bracket in 1988 and after, according to TRA86. The maximum capital gain rate was raised to 35 percent when the highest corporate rate bracket was increased in 1993.|
|source: "Table 1. U.S. Corporation Income Tax: Tax Brackets and Rates, 1909–2002," in Corporation Income Tax Brackets and Rates, 1909–2002, Internal Revenue Service, Fall 2003, http://www.irs.gov/pub/irs-soi/02corate.pdf (accessed March 10, 2005)|
|19415, 7||Taxable income $38,461.54 or less:|
|Taxable income over $38,461.54||31.009|
|1942–19455, 7||Taxable income $50,000 or less:|
|Next $15,000||27.009, 10|
|Next $5,000||29.009, 10|
|Next $25,000||53.009, 10|
|198722, 23||First $25,000||15.00|
in 2005 approximately $518 billion will be paid to forty-eight million Americans. As of December 2004, Social Security recipients included thirty million retirees, 6.2 million disabled workers, 4.9 million dependents, and 6.7 million survivors. For retirees overall, Social Security represented 39% of their income, but two-thirds depended on Social Security for 50% or more of their income. The SSA estimates that 22% of retirees depend on Social Security for all of their income. The average monthly benefit check for retirees in December 2004 totaled $955; disabled workers received somewhat less, averaging $894 per month.
social security reform. Since its inception during the Great Depression of the 1930s the Social Security program has been a source of partisan contention and debate. Signing it into law on August 14, 1935, President Franklin D. Roosevelt said, "We can never insure one hundred percent of the population against one hundred percent of the hazards and vicissitudes of life, but we have tried to frame a law which will give some measure of protection to the average citizen and to his family against the loss of a job and against poverty-ridden old age." Debates have centered on funding the program, on the role of the government in the financial planning of individuals, and on ways to maintain the program during future years as the population ages and fewer wage earners are contributing to the plan.
According to the Social Security Administration, in 2005, 3.3 workers were contributing to the program for each beneficiary. As workers born during the baby boom that followed World War II begin to retire, there will be fewer workers contributing to the plan, because the succeeding generations are smaller. The SSA estimated in Social Security Basic Facts that by 2031 there will be only 2.1 workers contributing for each beneficiary.
In their 2005 report the Social Security trustees projected that tax revenues will fall below program costs in 2017. At that point, the trust fund will be used to pay the shortfall so that payments to beneficiaries can continue at expected levels. The trust funds will be exhausted in 2041, and the program's annual income will only be able to fund 70% of the benefits currently available to beneficiaries. How best to prepare for that situation is a fiercely debated issue among conservatives and liberals. During early 2005 President George W. Bush campaigned for significant reform of the Social Security program, including allowing younger workers to opt out of the Social Security plan and establish their own retirement savings accounts. Democrats did not accept that a radical reform of the program was necessary to recover the shortfall, as the actual deficit over a seventy-five-year period, according to the 2005 Social Security Trustees Report, was expected to be only 1.92%. Democrats have suggested that such a sum could be recouped by removing the cap on income subject to FICA taxes, for instance, but President Bush adamantly dismissed any alternatives that could be construed as a tax increase.
Taxes on Consumption
excise taxes. Taxes on consumption include sales and excise taxes. Although there is no federal sales tax, the federal government does levy excise taxes on such items as airplane tickets, gasoline, alcoholic beverages, firearms, and cigarettes. Excise taxes on certain commodities are often hypothecated, meaning they are used to pay for a related government service. For example, fuel taxes are typically used to pay for road and bridge construction or public transportation, or a cigarette excise may go to cover state-supported health care programs. Excise taxes can be intended to generate revenue or to discourage use of the taxed product (as in high cigarette taxes that raise the per-pack cost in an attempt to discourage smoking).
Federal excise taxes during 2004 included:
- A 3% tax on amounts paid for local and long-distance telephone service
- A tax of 7.5% on the amount paid for an airline ticket, plus a flat fee of $3.10 for each domestic segment of an airline trip
- Taxes of 18.4 cents per gallon for gasoline and 19.4 cents per gallon for aviation fuel
- A 10% tax on the sale price of sport fishing equipment sold by the manufacturer
- A tax of 3% on the sale price of electric outboard motors and sonar devices
- A tax of 75 cents per dose on certain vaccines, including those used to prevent diphtheria, tetanus, polio, measles, mumps, hepatitis B, and chicken pox
- A tax of 12% of the sale price of truck chassis and bodies, semitrailer chassis and bodies, and tractors of the kind chiefly used for highway transportation
- A tax of $3 per passenger on certain ship voyages
Alcohol, tobacco, and firearms are also subject to federal excise taxes. As of January 2005, taxes on alcohol included five cents on each twelve-ounce can of beer, $2.14 on a 750 ml bottle of spirits, and twenty-one to sixty-five cents per bottle of wine, depending on the alcohol content. Cigarettes were taxed at thirty-nine cents or eighty-two cents per pack, depending on the size of the cigarette. Pistols and revolvers were taxed at 10% of the sale price, and all other firearms and munitions were subject to a tax of 11% of the sale price.
Taxes on Wealth
estate taxes and gift taxes. Large gifts and estates are subject to tax by the federal government. Arguments have been put forward that these taxes help economic growth by encouraging wealthy individuals to spend rather than save their money; critics, however, fear that such taxes discourage long-term savings and unfairly hurt family farms and family-owned businesses. According to Gary Robbins of the Heritage Foundation in "Estate Taxes: An Historical Perspective," a presentation delivered to the Department of Treasury's "Roundtable on Jobs, Growth and the Abolition of the Death Tax" in Washington, D.C., in November 2003, estate taxes date back to ancient Egypt, when transferred property was subject to a 10% tax. Civilizations ranging from ancient Rome to feudal England assessed duties on estates, and estate taxes were imposed in the United States for the first time during the period 1797 to 1802. During the nineteenth century estate taxes were in effect periodically to finance military costs associated with wars. However, in the early twentieth century the estate tax (and a similar "gift tax" imposed on transfers of property by the living) became fixtures in the U.S. tax code. The Revenue Act of 1916 imposed an estate tax that chiefly affected the wealthiest Americans, with a 1% tax on estates over $50,000 (approximately $11 million by modern standards, according to Robbins) and a 10% tax on estates over $5 million ($1 billion in 2003 dollars). The gift tax was added in 1924, and increases were approved in the 1940s that taxed the largest estates up to 77%. Throughout the twentieth century, the lowest bracket remained relatively steady for long periods, at 3% from 1943 through 1976, and at 18% since 1977.
Tax reform in 1981 led to a graduated reduction in the top rate to 55% and increased the amount exempt from estate taxes to $600,000, but rates edged upward again during the following two decades. Provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 gradually phase out the estate tax by 2010, but in 2011 rates will return to 1997 levels of 18% for estates over $1 million and 55% for estates over $3 million. During 2005, according to the IRS, only about 2% of estates actually owed taxes because credit amounts effectively eliminated the tax on estates smaller than $1.5 million and on gifts under $1 million.
Economic Growth and Tax Relief and Reconciliation Act of 2001
The Economic Growth and Tax Relief and Reconciliation Act of 2001 (EGTRRA, initiated by the administration of George W. Bush and so often known simply as the "Bush tax cuts") instituted a series of tax rate reductions and incentive measures to be phased in over several years. Included in the law were increases in income tax credits for families with children, raising the per-child credit from $500 to $1,000, and increasing the amount credited for childcare expenses. The act also provided credits for participation in savings plans, and it reduced estate, gift, and generation-skipping transfer taxes (GST; a special tax on property transfers from grandparents to their grandchildren) but did not address business taxes. Changes to the tax rates instituted in EGTRRA included the addition of a 10% income tax bracket for individuals with income up to $6,000, heads of households up to $10,000, and married couples filing jointly up to $12,000. The 28%, 31%, and 36% brackets were to be phased down by three percentage points by 2006, and the highest tax bracket was to be lowered from 39.6% to 35%. EGTRRA was designed to "sunset" (expire) in 2011 unless additional measures are passed to extend its provisions.
The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) accelerated implementation of EGTRRA, reduced taxes on capital gains and dividends, and increased deductions for property depreciation. Capital gains taxes were reduced from 20% to 5%–15% determined by overall income bracket, and the rate on dividends was similarly set at 5%–15% depending on income.
Following implementation of the tax cuts, total income tax receipts from individual and corporate taxpayers were at the lowest level as a share of GDP since 1942, and federal receipts from personal income taxes were at the lowest level since 1966, according to Isaac Shapiro in "Federal Income Taxes, as a Share of GDP, Drop to Lowest Level Since 1942, According to Final Budget Data" (Center on Budget and Policy Priorities, October 21, 2003).
THE FEDERAL BUDGET
Funds collected by the government include proceeds from the sale of land, capital, or services, and collections from taxes, fines, duties, and fees. In January 2005 the Congressional Budget Office (CBO) reported in The Budget and Economic Outlook: Fiscal Years 2006 to 2015 that the United States government collected approximately $1.88 trillion in 2004. As a result of the tax-cutting measures instituted by the Bush administration, these sums were 7.2% lower overall than in 2000, when $2.03 trillion was collected. Individual income tax revenue, at $809 billion in 2004, was down 19.5% from the $1,004.5 billion collected in 2000, and tax revenue declined in other categories as well. Corporate tax revenue decreased 8.6%, from $207.3 billion in 2000 to $189.4 billion in 2004, and estate and gift tax revenue dropped 14.5%, from $29 billion to $24.8 billion. Miscellaneous receipts also declined (23.8%), from $42.8 billion to $32.6 billion. Areas that showed increases between 2000 and 2004 included social insurance taxes (1.5%) from $652.9 billion to $733.4 billion, excise taxes (1.5%) from $68.9 billion to $69.9 billion, and customs duties (6%) from $19.9 billion to $21.1 billion.
The Budget and Economic Outlook also reported federal revenue by source as a percentage of GDP. Since the
end of World War II, revenues as a share of GDP have generally ranged between 16% and 19% (averaging about 17.5%), with 2000 representing the highest ever at 20.9% (tied with 1944). By 2004, according to the CBO, total revenue as a percentage of GDP had been reduced 22% to 16.3% of GDP, the lowest rate since the 1950s. The impact of the Bush tax cuts can be seen in the reduction of individual income taxes from 10.3% of GDP in 2000 to just 7% in 2004. During the same period, according to the Budget and Economic Outlook, corporate income taxes declined from 2.1% of the GDP to 1.6%; social insurance taxes went from 6.7% to 6.3%; excise taxes were reduced from 0.7% to 0.6%; estate and gift taxes decreased from 0.3% to 0.2%; and miscellaneous receipts declined from 0.4% to 0.3% of GDP. Customs duties remained constant between 2000 and 2004 at 0.2% of GDP.
Figure 8.1 shows the changes in main sources of federal revenue as a percent of GDP since 1960 and projects further changes through 2015. The CBO reported that over the period from 1962 through 2004 social insurance taxes had shown the biggest rise as a percent of GDP, from 3% in 1962 to 6.3% in 2004, while corporate income taxes had shown the largest decrease, from a high of 4.2% of GDP in 1967 to 1.6% in 2004. By 2015 total federal revenues are projected to reach 19.5% of GDP.
Federal outlays are payments made by the government for goods, services, or property and include the issuance of bonds and interest payments on coupons. In The Budget of the United States Government: Historical Tables Fiscal Year 2005, statistics on federal spending since the 1960s show that budget priorities can change significantly over time. According to "Outlays by Function and Subfunction 1962–2009," national defense spending in 1962 totaled $52.3 billion, approximately 49% of the $106.8 billion in total federal outlays that year. Spending for education and social services in 1962 equaled $1.2 billion (about 1% of outlays), and Social Security spending reached $14.4 billion (13.5% of outlays). At $6.9 billion, net interest on Treasury debt securities amounted to 6.5% of total federal outlays in 1962. By 2003, defense spending, at $404.9 billion, comprised only 18.8% of the $2.2 trillion in federal expenditures. Spending for education and social services in 2003 had increased to $82.6 billion (3.8% of outlays), and Social Security expenditures, at $474.7 billion, had risen to 22% of federal outlays. Net interest on Treasury debt securities had risen to $236.6 billion, 11% of all government expenditures.
When the government spends more money than it takes in, the difference is known as the "budget deficit." According to the Monthly Treasury Statement (February 2005) released by the Financial Management Service (FMS) of the Department of Treasury, during fiscal year 2004 the federal government took in nearly $1.9 trillion and spent almost $2.3 trillion, leading to a budget deficit of approximately $412 billion. "Profile of the Economy" (Office of Macroeconomic Analysis, Treasury Bulletin, March 2005) indicated that the 2004 budget deficit was $34 billion more than the deficit during the previous fiscal year.
In The Budget and Economic Outlook the CBO reported that the budget deficit in 2004 equaled 3.5% of the GDP for that year. This was the highest deficit since 1993, when it was 3.8%. Since the 1960s the federal government has operated with a budget surplus only four times: 1998 (0.8% of GDP), 1999 (1.4%), 2000 (2.5%), and 2001 (1.3%). Over the twenty-year period 1985 through 2004, the federal government averaged an annual deficit of 2.19% of GDP. For fiscal year 2005 the federal budget projected an increase of $15 billion in the budget deficit but then anticipated reducing the deficit to $207 billion by fiscal year 2010. The Bush administration maintained that lowering tax rates would stimulate economic activity and lead to increased federal revenue. Administration officials asserted that when combined with reduced government spending, the higher revenue amounts would reduce the budget deficit by half, a contention disputed by many economists.
Whenever the federal government has a budget deficit, the Treasury department must borrow money to cover the difference. The total amount of money that the Treasury has borrowed over the years is known as the "public debt." Most of the federal debt is in the form of Treasury securities (bonds issued by the government to finance federal operations). Through the issuance of securities the government borrows money with a promise to pay it back with interest after a set term. Treasury bills (issued with terms of less than one year), Treasury notes (maturing between one and ten years), and Treasury bonds (with set terms of more than ten years) are among the most common securities and are actively traded on a secondary market. Savings bonds, also issued by the Department of Treasury, are different from other government securities in that they are redeemable only by the person to whom they are registered and may not be traded. Savings bonds may be redeemed without penalty after five years, although they continue to earn interest until thirty years from the purchase date.
Table 8.4 provides the amount of debt held by the federal government during selected years from 1791 through 2005. Great increases in federal debt have often been associated with costly wars, including a 3,725.7% increase during the Civil War and Reconstruction period of the 1860s, an 878.4% increase during the decade of the First World War, and a 499% increase during World War II. However, during the relatively peaceful 1980s federal debt nevertheless increased 247.6%, from $930.2 billion to $3.2 trillion. Between 1990 and 2000, federal debt rose 75.5%, and between 2000 and 2005 it rose 36.2%. As of March 2005, about $4.5 trillion in federal debt was owed
|Outstanding national debt, selected years 1791–2005|
|[Includes legal tender notes, gold and silver certificates, etc.]|
|*Rounded to millions|
|source: Adapted from "The Debt of the U.S.: Historical Debt Outstanding—Annual," in Facts and Figures, Bureau of the Public Debt, Department of Treasury, March 4, 2005, http://www.publicdebt.treas.gov/opd/opd.htm#history (accessed March 9, 2005)|
to individuals, corporations, state or local governments, or foreign governments, and approximately $3.2 trillion in debt was held by trust funds, revolving funds, and special funds within the government itself.
STATE AND LOCAL TAXES
In the United States, many states and local government entities levy taxes, including taxes on corporate income, personal income, and property. In addition, most states charge sales taxes on retail transactions. According to the U.S. Census Bureau in Federal, State, and Local Governments: 2003 State Government Tax Collections (February 2005), state revenue from taxes equaled $549 billion in 2003, which amounted to $1,891.57 per person. States with large populations, such as California, New York, Texas, Florida, and Pennsylvania, collected the most taxes in 2003, but Hawaii, Connecticut, Minnesota, Delaware, and Vermont had the highest taxes per capita. Table 8.5 ranks states by total taxes and per capita amount during 2003. Table 8.6 shows taxes and other sources of revenue for the nation's largest cities in 2001.
As of 2004 forty-three states and the District of Columbia imposed income taxes. The states that did not tax income were Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Two additional states, Tennessee and
|States ranked by total taxes and per capita amount, 2003|
|(Amounts are in thousands. Per capita amounts are in dollars)|
|Total tax||Total tax per capita|
|source: "States Ranked by Total Taxes and Per Capita Amount: 2003," in Federal, State, and Local Governments: 2003 State Government Tax Collections, U.S. Census Bureau, February 2005, http://www.census.gov/govs/statetax/03staxrank.html (accessed March 10, 2005)|
|United States||546,694,430||United States||1,883.56|
|44||New Hampshire||1,959,211||44||New Hampshire||1,521.13|
New Hampshire, taxed only personal income derived from dividends and interest, according to the Federation of Tax Administrators (FTA; www.taxadmin.org). In 2004 several states imposed a single rate for all income levels, including Colorado (4.63%), Illinois (3.0%), Indiana (3.4%), Massachusetts (5.3%), Michigan (4.0%), Pennsylvania (3.07%), and Rhode Island (25% of federal tax liability). Many states had devised tax codes based on income brackets that varied in number from two in Connecticut to ten in Missouri and Montana. According to the FTA, the highest income tax rates among the states in 2004 included 11% on income over $76,199 in Montana and 9.5% on income over $30,000 in the District of Columbia. According to the U.S. Census Bureau in Federal, State, and Local Governments, the states collected $181.9 billion in personal income taxes in 2003.
A property tax is tax levied on the value of land, buildings, businesses, or personal property, including business equipment and automobiles. According to the
|City revenues, by source, for largest cities, 2001|
|[In millions of dollars (58,523 represents $558,523,000,000). Cities ranked by enumerated population as of April 1. Data reflect inclusion of fiscal actitvity of dependent school systems where applicable.]|
|Intergovernmental||General revenue from own sources|
|From federal government||From state/local government||From local government||Taxes||Current charges||Miscellaneous||Employee retire ment revenue|
|Sales and gross receipts||Parks and recreation||Interest earnings|
|Cities ranked by 2000 population||Total revenue||Total||Total||Total||Total||Property||Total||Geneal sales||Public utilities||Total||Sewerage1||Total||Utility revenue2|
|—Represents or rounds to zero.|
|1Includes solid waste management.|
|2Includes water, electric, and transit.|
|3Represents, in effect, city-county consolidated government.|
|source: "No. 449. City Governments—Revenue for Largest Cities: 2001," in "Section 8: State and Local Government Finances and Employmen t," Statistical Abstract of the United States, 2004, http://www.census.gov/prod/2004pubs/04statab/stlocgov.pdf (accessed March 10, 2005)|
|New York, NY||58,523||51,262||19,841||2,806||16,947||88||31,421||23,579||8,276||4,832||3,679||431||5,103||55||971||2,740||887||2,869||4,392|
|Los Angeles, CA||11,287||6,056||1,035||297||596||142||5,021||2,519||753||1,210||483||610||1,688||83||492||814||483||3,630||1,602|
|San Diego, CA||2,574||2,080||351||109||167||75||1,729||959||228||646||413||44||324||48||183||445||146||240||254|
|San Antonio, TX||2,463||984||148||41||100||—||836||409||195||199||134||22||255||27||154||171||126||1,426||53|
|San Jose, CA||1,493||1,484||245||89||9||58||1,239||684||222||293||169||97||340||20||155||215||107||18||−9|
|San Francisco, CA3||6,095||4,893||1,740||378||1,356||—||3,153||1,747||626||674||387||89||1,053||37||152||352||255||337||865|
|El Paso, TX||550||441||65||46||11||—||375||206||107||93||68||22||109||—||59||60||28||62||47|
|Ft Worth, TX||842||541||33||—||33||—||508||320||157||125||122||—||100||—||78||89||53||129||172|
|Oklahoma City, OK||860||694||75||45||29||—||620||327||38||281||252||27||182||10||70||111||57||61||105|
|New Orleans, LA||974||886||191||60||131||—||694||392||155||210||140||48||193||—||70||109||50||55||33|
|Las Vegas, NV||544||543||208||—||172||31||335||143||70||39||—||34||123||—||57||69||27||—||—|
|Long Beach, CA||971||832||145||57||76||13||686||215||67||108||37||57||397||—||73||75||31||138||—|
U.S. Department of Treasury, property taxes in the United States date back to the Massachusetts Bay Colony in 1646, and the separate states began imposing property taxes soon after declaring independence from Britain. In the early twenty-first century, property taxes are the primary means of generating income for local governments in the United States, including cities, school districts, and counties. According to the U.S. Census Bureau in Federal, State, and Local Governments, the states collected $104.7 billion in property taxes in 2003.
Local governments determine the tax rate and the percent of the property's value against which taxes are assessed. For example, in New York City, taxes on residential properties of one, two, or three units were calculated at a rate of 15.094% on 6% of a property's assessed value in 2005. In Tax Rates and Tax Burdens Gandhi compared residential property taxes in the largest city in each state in 2003 and found that Providence, Rhode Island, had the highest property taxes at $3.88 per $100 of a property's assessed value.
As of 2004 state sales taxes were charged in all states except Alaska. In some areas, local governments also levied sales taxes. In 2004, according to the FTA, state sales taxes ranged from 2.9% in Colorado to 7% in Mississippi, Rhode Island, and Tennessee. States often limit the percentage a local government can charge in sales taxes. Nevertheless, the combined state and local sales taxes in 2004 ranged up to 11% in Alabama, 10.625% in Arkansas, 10.5% in Oklahoma, and 10.25% in Louisiana. In Alaska, where there was no state sales tax in 2004, local governments were authorized to levy up to 7%. According to the U.S. Census Bureau, in Federal, State, and Local Governments: 2003 State Government Tax Collections, the states collected $273.8 billion in taxes on sales and gross receipts, which equaled $943.43 per person.
CURRENT ISSUES IN TAXATION
The impact of taxes on the economy is a source of never-ending debate in U.S. politics. Taxing personal income decreases the spending power of the individual; however, government spending can, to a certain degree, fuel the economy. Limited taxation is favored by those who believe that workers and companies with more available money to spend will participate to a greater extent in the economy. This, they say, will lead to economic growth. However, others observe that cutting taxes without severely reducing government spending quickly leads to large budget deficits and undermines the government programs that provide a social safety net to the disadvantaged.
President Bush was reelected in 2004 under the promise of revamping America's tax system. A variety of proposals have been put forward, including a national sales
tax that would replace all other forms of federal taxes. President Bush's proposal, however, does not advocate such a radical shift in tax policy. Building on his record of cutting income taxes, the president favors simplifying the tax bracket system and making the provisions of EGTRRA permanent. The proposal is based on the administration's belief that "countries with low taxes, limited regulation, and open trade grow faster, create more jobs, and enjoy higher standards of living than countries with bigger, more centralized governments and higher taxes. … If people are given the freedom to create, they do. If people are given a stake in the outcome, they succeed" (The President's Agenda for Tax Relief, April 29, 2003).
The president asserts that his policies will reduce poverty by lowering taxes for low- and lower-middle income families. Figure 8.2 shows the estimated impact of federal tax cuts on a single parent who has two children and who earns between $22,000 and $30,800 per year. Figure 8.3 represents White House projections of the percent reduction in income tax burden for a married couple with two children and one income. According to The President's Agenda for Tax Relief, two-career families would receive additional reductions. In addition, the administration asserts that tax breaks benefit families by helping them reduce their debt.
Critics of the president's tax policy point out that changes in the tax structure unfairly shift the burden from corporations and wealthy individuals to low- and middle-class wage earners, that tax cuts already instituted have erased the federal surplus built up in the late 1990s, and that further tax cuts will lead to unacceptable increases in government debt. In a letter to the President's Advisory Panel for Tax Reform (March 18, 2005), Cassandra Q. Butts and John S. Irons of the Center for American Progress concluded, "Overall, the federal tax system has become increasingly reliant on the regressive payroll tax, has shifted the burden of tax payment from the wealthy to the middle class, and has allowed corporations to avoid paying their fair share of taxes. The president's stated future goals for the tax system … will only exacerbate the degree to which the system has become unfair."