The Tax System of the United States
The Tax System of the United States
Contents
Introduction…………………………………………………………………3
1. Federalism & the Tax System………………………………………...4
2. Federal Taxes and Intergovernmental Revenues.
Tax Reform……7
3. The Progressivity of the Tax System.
Political Influences on the Tax System………………………………….……………………………..12
Conclusion…………………………………………………………………16
Bibliography……………………………………………………………….18
Introduction
The
purpose of our research - to characterize US tax system. First we shall tell
about main principles of US tax system. In chapter 1 we cover principles of
federalism in tax system.
In chapter 2 we shall
discuss the basic federal taxes and intergovernmental revenues. Also chapter 2 covers main US tax reforms and their
influences on a tax policy as a whole. After examining some basic facts about
the tax system, the remainder of tile chapter turns to matters dealing with tax
policy.
One issue that has
surfaced with regard to individuals taxes is the degree of progressivity of
particular taxes, but a more relevant consideration is the degree of
progressive of the tax system as a whole. It is a subject of chapter 3. If some
taxes are regressive while others are progressive, their effects can offset one
another, and a very regressive tax might be acceptable, or even desirable,
within the context of the entire, tax system. After all we shall tell about
political influences on the tax system.
Chapter 1
Federalism & the Tax System
Let's tell some words about a tax
policy all over again. One important aspect of tax policy is that the optimal
provisions for one type of tax will often depend on the way in which other
taxes are levied. A tax should be efficient and equitable when analyzed on its
own, but often the efficiency and equity of a tax depend upon how it fits in
with the whole system of taxes. So, taxes must be viewed as individual
components of an overall tax system to really understand their effects.
The United States has a federal
system of government, and, followings that model, the tax system can be divided
into the three major categories of federal, state, and local taxes. Federal,
taxes make up about 56 percent of total taxes, although federal expenditures
are: only about half of total expenditures. The difference occurs because a
substantial fraction of state and local government expenditures are, financed
by federal government grants. Intergovernmental grants make up nearly
one-third of local government revenues. One of the goals of this chapter is to
examine how the various levels of government raise revenues to finance their
expenditures.
The federal government collects more
in revenues than all other governments in the United States combined. Table 1
lists the percentage breakdown of all government own-source revenues and
own-source revenues from major tax bases. Own-source revenues excludes
intergovernmental grants, which are discussed in a separate section later, but
includes revenues collected from fees and user charges, which might ordinarily
not be considered as tax revenue. As table 1 shows, the federal Government
collects 56.4 percent of total government revenues, with states collecting 24.3
percent and local 19.3 percent. [1, p.305]
Although all levels of
government tend to collect revenues from a variety of sources, more taxes than
all table 1 shows that the different levels of government rely on different tax
bases to state and local different degrees. Most income taxes are collected by
the federal government, which collects 81 percent of all individual income
taxes and 81.5 percent of all corporate income taxes. States collect about 17
percent of both individual and corporate income tax payments, and local
governments collect less than 2 percent. Thus, while states rely to a
significant degree on income tax collections, the income tax is primarily a
federal tax. When considering the income tax from an equity standpoint, this
is even more true because most states base their income tax structures on the
federal income tax structure, so changes in federal tax laws can have a
significant effect on state income tax collections, both in terms of the amount
of tax collected and in terms of the distribution of income tax payments among
taxpayers.
The tax that is most
clearly assigned to one level of Government is the property tax. More than 96
percent of property taxes are collected by local governments. Sales and gross
receipts taxes, taxes are collected primarily by state governments. Although
62.9 percent of sales and gross receipts taxes are collected by states, both
the federal government and local governments collect a significant amount. The
federal government collects 24 local governments 24 percent of sales and gross
receipts taxes, mostly through federal excise taxes on motor fuel, alcohol, and
tobacco. [1, p.307] Local governments collect 13. 1 percent of sates and
gross receipts taxes, coming from a combination of local general sales taxes,
excise taxes on gasoline, and other less significant excise taxes.
Stepping back to examine
the overall tax system, we see that the federal government relies primarily on
income taxes, state governments on sales taxes, and local governments on
property taxes. This division makes some sense when one considers the mobility
of tax bases.
Although the property tax
has remained a local tax, the income tax is becoming, increasingly important at
the state level, as will be discussed later, so states might be viewed as
encroaching on a traditionally federal tax base. Likewise, the federal
government collects a significant amount of sales and gross receipts taxes,
primarily as excise taxes, which might be viewed as taxing a state tax base.
One factor relevant to the discussion of a federal value added tax is that, as
a consumption tax, it would be placed on a tax base that has traditionally been
used by state governments. This was less of an issue when the value added tax
was adopted by European governments because tax systems in Europe tend to be
more centralized than the tax system in the United States.
So, we can divide US tax
system into the three major categories of federal, state, and local taxes.
Intergovernmental grants make up nearly one-third of local government revenues.
The federal government collects more in revenues than all other governments in
the United States combined.
Most income taxes are
collected by the federal government, which collects 81 percent of all
individual income taxes and 81.5 percent of all corporate income taxes. Thus,
while states rely to a significant degree on income tax collections, the income
tax is primarily a federal tax.
We see that the federal
government relies primarily on income taxes, state governments on sales taxes,
and local governments on property taxes. This division makes some sense when
one considers the mobility of tax bases.
Chapter 2
Federal Taxes and Intergovernmental
Revenues. Tax Reform
The federal government
relies on income and payroll taxes for the vast majority of its revenues.
Table 2 shows the percentage breakdown for four categories of federal tax
revenues and shows that the personal income tax is by far the most significant
source of federal government revenue. Social insurance payroll taxes, which
consist mostly of Social Security and Medicare taxes, make up the
second-largest category, and this category is the only one that increased its
percentage contribution from 1990 to 1999. Both corporate income taxes and
excise taxes have fallen slightly in importance over that period.
The increased importance
of Social Security taxes is worth considering from an equity standpoint.
Although the income tax structure is designed to be progressive, the Social
Security tax structure is regressive because it taxes income at a flat rate up
to t maximum amount and is not collected on income above the maximum. [2,
p.122]
When Social Security
taxes were relatively low, the regressive nature of the tax might not have been
much of an issue, but with rising Social Security tax rates and uncertain
future benefits, the issue is worth considering. The progressivity of the tax
system is reduced when social insurance taxes replace income taxes. Although
the expected future benefits are a relevant and offsetting factor, normally the
progressivity of the tax structure is analyzed independently of the
distribution of tax benefits.
One of the important
points to note from the numbers in table 2 is that income and payroll taxes
make up about 90 percent of federal government revenues. The bulk of those
taxes are levied on individuals in the form of the individual income tax and
social insurance taxes. [1, p.320]
One of the major sources
of revenues for lower-level governments is intergovernmental revenue. Revenues
collected by the federal government are distributed through grants to state and
local governments, and state governments also provide financial assistance to
local governments. Intergovernmental revenues make up about 22 percent of total
state government revenues and 33 percent of local government revenues. [1,
p.320] There is some double counting here because the federal government can
provide revenues to states, who then distribute revenues to localities. Also,
local governments sometimes borrow from state governments and repay loans, so
intergovernmental revenues to state governments can come from both federal and
local governments. However, the most significant intergovernmental revenues
consist of federal aid to state and local governments.
As a percent of state and
local government spending, federal aid peaked in the late 1980s at about 24
percent of state and local government expenditures and has since declined to
about 17 percent. Although they have been declining slowly in importance,
intergovernmental revenues are still large and can have significant effects on
government finance.
Although each individual
intergovernmental transfer program will have its own motivation, there are
three basic reasons why intergovernmental transfer programs might be
established: (1) higher-level governments provide money to encourage certain
types of programs by lower-level governments; (2) taxation for lower-level
governments can be shifted to higher-level governments, where taxes are harder
to avoid; and (3) programs are established for equity reasons, to give poorer
states or localities parity with richer states or localities in funding
government programs. [2, p.158]
But state governments
rely mainly on sales and income taxes for their revenues, while local
governments rely mainly on property taxes.
Now we shall tell about
tax reforms. Tax laws are continually being modified at all levels of
government. Indeed, most changes in tax law tend to be small changes that
directly affect only a few taxpayers, and with good reason. Changes in any
laws tend to be initiated as a result of a demand for the change, and special
interests will consistently demand changes that will benefit them, while the
general public will remain on the sidelines of most policy debates. Thus, the
tax laws change as one small provision after another is added to the tax code
as a result of requests from special interests.
Although each change by
itself may have a plausible rationale, changes in the tax code tend to be in
the form of loopholes that allow some taxpayers to reduce their tax payments.
This was the general idea that drove the federal income tax reform in 1996.
The tax code had so many loopholes in it that much income was escaping
taxation, making everyone’s tax rates higher. If all the loopholes and special
interest benefits could be done away with, everyone could have lower tax rates
but the tax system could still raise the same amount of revenue.
Thus, the idea of that
tax reform was to broaden the tax base by closing loopholes and making more
income subject to taxation and lowering rates to raise the same amount of
revenue. That effort at reform was mostly successful for two reasons. It
considered the tax system as a whole rather than piecemeal, and the reform
proposals were revenue neutral, which meant that they all proposed a more
efficient tax structure that would raise the same amount of revenue. [1, p.356]
When tax reform takes place by examining
one small tax issue after another, special interests can have undue influence
over the reform process, and the resulting reform will tend to favor special
interests rather than the general public interest. Small changes to the tax
code will not affect most people very much one way or the other, so it will not
pay them to get involved in the debate, whereas special interests can benefit
substantially from small changes in the tax code. Thus, when the tax code is
changed a little at a time, special interests will tend to benefit, and the tax
code will become increasingly complex as loopholes are added to the tax system
one at a time.
This problem of an overly complex tax
code ridden with loopholes may be overcome by proposing a complete overhaul of
the tax system that does away with all the loopholes in exchange for lower tax
rates for everyone. Everyone tends to lose some special interest benefits with
such a reform, but, overall, the more efficient tax code with lower rates can
more than make up for the loss of these special interest benefits. Thus, a
comprehensive tax reform has the potential to be a Pareto superior move, and
all citizens can agree to give up their loopholes in exchange for a more
efficient tax system that improves the welfare of all. This was the philosophy
underlying federal tax reform in 1996.
Since the 1996 tax reform, changes in
the tax code have been small ones, and this type of change is likely to benefit
special interests rather than further the general public interest. Cynics
might even suggest that by 1996, Congress had created just about all the
special interest loopholes that it could fit into the tax code and that to
create any more would have required taking away someone else’s. Therefore,
Congress moved to eliminate as many of the special interest provisions as it
could so that it could start giving them out again, one at a time, in exchange
for renewed political support from the favored special interests. An optimist
can hope that once a better tax system has been enacted, Congress and the
general public will resist tampering and might even improve upon it.
For special interests in the private
sector, the tax code provides a method by which they might be able to produce
benefits for themselves. For governments, the tax system is a method of
raising revenues. With the federal government running a substantial deficit
and states and localities also finding themselves strapped for revenues, many
people see tax reform as an opportunity to generate more revenues for cash-strapped
governments. This view is not universal, however, and others think that
governments spend too much and that taxes should be cut. Inevitably, when tax
matters enter the political debate, there will be tension between those who
think the government needs to increase taxes and those who think taxes need to
be cut.
Both groups should agree that however
much revenue the government raises, it should do so as efficiently as
possible. Thus, there is a possibility to get agreement among all parties to
create a more efficient tax structure if they can lay aside differences
regarding whether the government should increase or decrease its revenues.
Agreeing to adhere to the principle
of revenue neutrality when changing the tax structure partitions the policy debate
so that issues regarding how much revenue the government should raise can be
considered separately from efficiency and equity issues. On one side of the
partition, legislators can debate how to create a fair and efficient tax
structure, leaving the amount of revenues unchanged, and, on the other side of
the partition, they can debate whether tax rates should be raised or lowered to
collect the right amount of revenue.
So, the federal
government relies on income and payroll taxes for the vast majority of its
revenues. Social insurance payroll taxes, which consist mostly of Social
Security and Medicare taxes, make up the second-largest category. When Social
Security taxes were relatively low, the regressive nature of the tax might not
have been much of an issue, but with rising Social Security tax rates and
uncertain future benefits, the issue is worth considering.
One of the major sources
of revenues for lower-level governments is intergovernmental revenue. Revenues
collected by the federal government are distributed through grants to state and
local governments, and state governments also provide financial assistance to
local governments.
But tax laws are
continually being modified at all levels of government. Although each change by
itself may have a plausible rationale, changes in the tax code tend to be in
the form of loopholes that allow some taxpayers to reduce their tax payments. Thus,
the idea of tax reform was to broaden the tax base by closing loopholes and
making more income subject to taxation and lowering rates to raise the same
amount of revenue.
Chapter 3
The Progressivity of the Tax System.
Political Influences on the Tax System
One of the important
issues in the analysis of individual taxes in the previous chapters was the
progressivity of taxes. The progressivity of individual taxes is of minor
importance, however, when compared with the progressivity of the tax system as
a whole. For example, taxes on cigarettes are widely viewed as regressive taxes
because lower-income people spend a larger percentage of their incomes on
tobacco than do higher-income people. In general, regressive taxes are viewed
as inequitable, yet there is minimal resistance to increases in this regressive
tax because it is a sumptuary tax on a product that is increasingly viewed as
harmful to consume. There is not necessarily an inconsistency in calling for
an increase in a regressive tax and favoring a proportional or progressive tax
system if that one tax is a small part of the total system. Thus, the
progressivity of the tax system as a whole is more important than the
progressivity of any particular tax. [2, p.165]
Analyzing the entire tax
system is not an easy task, for several reasons. If one simply examines the
amount of taxes paid in one year when compared with people’s incomes for that
year, the degree of regressivity of the tax system is sure to be overstated.
Many people at the low and high ends of the income distribution in a particular
year are there because of temporary circumstances. People who are temporarily
unemployed, or college students who expect to have higher-paying jobs in a few
years, will have relatively high consumption and taxes when compared with their
incomes, and, at the other end of the income distribution, some people have
annual income may be especially high incomes in a year because they have
realized capital gains, such as might occur if one sold a business or even a
house that one has owned a long time. Thus, it may be more reasonable to look
at the progressivity of the tax system compared with lifetime income rather
than with income in a particular year.
It is very progressive at
the extreme ends of the income distribution, with the lower 2 percent of
individuals paying much less in taxes as a percentage of their incomes and the
upper 2 percent paying much more, relative to the rest of the population. But,
for most people, the tax system works out to be roughly proportional with
respect to income.
The most progressive tax in the tax
system is the income tax. [1, p.309] This should not be surprising because it
is designed to be progressive with respect to income. But sales and excise
taxes are consistently regressive with respect to income, which partially
offsets the progressivity of the income tax. States that do not tax food or
rent remove a substantial amount of the general sales tax burden from low-income
individuals, but included in excise taxes are taxes on gasoline, tobacco and
alcohol products, electricity, and phone service that obviously take a larger
percentage of income from lower-income individuals.
The overall progressivity of the tax
system is driven mainly by income taxes and by sales and excise taxes, which
make up the biggest share of the total tax burden. Sales and excise taxes are
slightly regressive overall, while income taxes are progressive enough to more
than offset the regressive effects of other taxes, making the tax system
progressive as a whole. This suggests that if the tax system were to start
relying more on consumption taxes, such as a value added tax, the progressivity
of the tax system might be reduced, and this is a concern for policymakers who
are examining such alternatives. A consumption tax structured like the current
income tax, on the other hand, could be designed to retain the current
progressivity of the tax system, so it would be less controversial from a
policy standpoint.
One can draw some general conclusions
about the progressivity of the tax system by looking at the lifetime tax burden
in this way, but the approach still has some possible problems. Most obvious
is accurately estimating who actually is paying taxes, but there may be deeper
problems with this way of looking at things as well. For one thing, people do
not have their entire lifetime incomes available for them to pay taxes at any
point in their lives. Someone who will have a much higher income in twenty,
years cannot use that future income to pay today’s taxes, so, for purposes of
fairness, we should be concerned about taxing people with low incomes heavily
now even if their incomes will be substantially higher in the future. This has
led some economists to back away from the concept of lifetime income and
instead examine the burden of taxes over a shorter period, such as five years.
By examining a period like five years, a temporary spell of unemployment
would have a smaller effect than if annual income were used as a benchmark,
but, at the same time, one would not place heavy tax burdens on people with low
incomes today who might have high lifetime incomes.
Another reason for examining the
progressivity of the tax system over a shorter period of time than an entire
lifetime is that the tax structure can change substantially over time, and any
estimate made now of a young person’s lifetime tax burden is sure to be in
error because of unforeseen changes in the future tax structure. From an
academic standpoint, it is interesting to estimate what the lifetime tax
burdens of various groups of people would be under the current tax structure,
but, if one is really interested in designing an equitable tax structure, there
is a great deal of uncertainty involved in forecasting future taxes. The
Social Security payroll tax provides a good example of a tax that had to rise
faster than originally forecast to provide sufficient revenues to maintain the
program. [2, p.183]
Yet another problem with this
approach is that it does not consider how the tax money is spent. If taxes are
the price we pay for government goods and services, then we should be concerned
with how well the burden of taxation matches up with the flow of government
services rather than just looking at taxes in isolation. The Social Security
payroll tax was explicitly designed to have some (but not complete)
correspondence with the expected benefits received. Although other taxes do
not match up so exactly with benefits received, a complete accounting from an
equity standpoint should include both government taxes and government benefits.
It is still worthwhile
to examine the issue of the progressivity of the tax structure, these caveats
notwithstanding. But, at the same time, we must recognize that any measure of
the progressivity of the tax system will be imperfect and must be considered in
the context of what it does and does not measure.
One can analyze the tax
system at length in an academic framework, yet real-world tax policy is made through
the political process rather than as a result of economic analysis. Thus, the
actual tax system will be the product of compromise among various interests in
the political arena. In this setting, economic analysis serves two roles.
First, it provides arguments that both sides use in the political debate on
taxes. No one says that he favors a particular tax, or a particular tax
reduction, because it will make him richer. Rather, political interests argue
that the tax changes they favor are in the public interest for a variety of
reasons. They argue that changes will make the tax system more fair or more
efficient, but, to make such arguments, they need to know enough about the
economics of the situation that they can use economic analysis to present their
cases in the most favorable light. But economic analysis is also used to
estimate what the effects of tax changes will be so that interests actually
will know which changes will benefit them, and by about how much. There is no
sense arguing for a change if it will provide little in the way of real
benefits.
If the democratic
political system truly were representative, everyone’s interests would be given
equal weight in designing the tax system. In reality, special interests tend to
dominate political debate because they are the ones who have the most to gain,
and interests with more wealth will be in a better position to use their
resources to steer the course of political decision making. This has the
potential for pushing the tax system toward a complex set of special interest
benefits giving loopholes to those who have political influence, while leaving
those who do not have much influence to bear increased tax burdens.
One problem is that when
special interests seek tax advantages, they will care little whether those
advantages enhance overall efficiency as long as they benefit the special
interests. Tax reforms that actually do enhance economic efficiency probably
will have a better chance of passing through Congress because they will have less
opposition than inefficient tax reforms, but this may not be enough to produce
an efficient tax system. [1, p.387] This is especially true when one considers
the tax system as a whole. One change in the tax laws may have a plausible
rationale but may be counterproductive when considered within the context of
the rest of the tax system.
Conclusion
The tax system in the
United States is a composite of federal, state, and local taxes. The federal
government raises more than half the tax revenues in the United States, with
state governments raising about a quarter, and local governments a little less
than that. Although there is not an absolute division among tax bases used by
the various levels of government, the federal government relies mostly on income
taxes, state governments rely most heavily on sales taxes (but also get
significant revenues from income taxation), and local governments rely most
heavily on property taxes.
Intergovernmental
revenues make up a substantial amount of state and local government revenues,
mostly in the form of federal government grants. The use of intergovernmental
revenues helps equalize expenditures across the nation, so that lower-income
areas are not as disadvantaged because of smaller tax bases. These revenues
also have the effect of lowering the state or local government tax price for
government spending, which encourages more state and local spending. This is
often the intention, as federal grants are made to entice lower-level
governments to spend more in certain areas. Because federal government
programs spread across the nation, intergovernmental revenues also make
different jurisdictions more similar and therefore lower intergovernmental
competition.
One of the significant issues with
regard to any tax, and especially with regard to the overall tax system, is its
degree of progressivity. The tax system in the United States is, overall,
progressive, with people at the extreme lower end of the income distribution
paying much less in taxes as a percentage of their incomes, and people at the
extreme upper end paying much more, than average. For people who are not at
the extremes of the income distribution, however, the tax system is roughly
proportional. Income taxes are the most progressive taxes as a group, while
sales and excise taxes are the most regressive, but the progressivity of income
taxes more than offsets the regressivity of sales taxes.
With regard to both equity and
efficiency issues, taxes are best considered within the context of the overall
tax system. Some taxes, such as cigarette taxes, may be very regressive, yet
they are a small part of the total tax payments of any group and therefore are
not viewed as unfair because of their regressiveness. Similarly, the efficient
tax treatment of dividends, capital gains, inheritances, and most kinds of
property depends upon how related tax bases are treated throughout the tax
system, so one cannot get a complete understanding of any individual tax
without seeing how it works as a part of the entire system of taxes.
Ultimately, the tax
structure is a product of the political system, so understanding the political
forces involved in changing the tax laws goes a long way toward understanding
the nature of the actual tax system, especially when the actual system seems to
deviate from what appears to be fair and efficient. Special interests tend to
have an undue influence over tax changes, as they do over legislation in
general, with the result that if tax reform takes place on a piecemeal basis,
the tax structure is likely to be increasingly riddled with special interest
benefits that erode the tax base and make the tax code inefficient. More
comprehensive tax reform has the chance of creating greater potential gains for
the general public, which increases the likelihood that reform will take place
in the general public interest rather than for the benefit of special
interests. The federal tax reform of 1996 serves as a model in this regard.
Bibliography
1. Dr. Randall G. Holcombe. The Tax
System in the United States. New York: Academic Press, 2000.
2. John Leslie Livingstone. The
portable MBA in Finance and Accounting. New
Jersey: John Wiley & Sons, Inc., 2002.
E-resources:
1. www.aimr.org/knowledge
2. www.afajof.org
3. www.mrc.twsu.edu
|