Taxes

What It Means

A tax is a fee that a government imposes, or levies, on a type of economic activity. For example, a tax can be imposed on the sale of a product or on the income that a business or person earns. The value of property is often taxed. Taxes are mandatory, meaning you have no choice but to pay them. Governments impose taxes in order to fund their expenses, which range from national defense to healthcare for the elderly to maintenance of a city park.

The amount a government taxes is not random. A government must first determine what its essential needs are. It must pay for the costs of running itself (its buildings, as well as its workers, whether these be street cleaners or judges), and it must pay for the services the country views as vital (most people, for example, would consider police and fire departments essential). Other expenses might be more discretionary, or dependent upon individual judgment. A national government’s decision to purchase more warplanes or a local government’s decision to upgrade the municipal swimming pool might be met with approval by some citizens and not others. Ultimately taxing and spending decisions are determined in the political sphere, such as city councils or national assemblies, where representatives of the government make choices about the use of limited sources of tax revenue. A challenge faced by most governments is that people generally like the benefits of government spending ‘they might enjoy a nicer pool for the community, or they might want the government to inspect meat and poultry for potential health hazards’ but they often do not like paying the taxes required to provides these services.

In addition to paying for expenses, taxes are used to achieve certain social and economic goals. For example, a government might want to redistribute wealth, taking money from high-income individuals and giving it to people who cannot support themselves, such as the disabled, the mentally ill, or people who have lost a job. Governments sometimes try to influence the behavior of individuals and businesses through taxes. A government might reduce taxes on businesses that invest in alternative energy sources, or it might tax goods, such as cigarettes and alcohol, to encourage people to consume less of them. Some organizations, such as charities, are often exempt from taxation in order to support their activities. Tax policies are important not only because they pay for services and influence behavior but because they ultimately decide who will have control over a large part of an economy’s resources. This, in turn, has an enormous effect on the functioning of the economy.

When Did It Begin

As governments cannot exist without taxes, the system of taxation has existed since ancient times. As in countries today, governments in the past devised numerous ways to collect money for their expenses. In ancient Egypt the government for some time taxed cooking oil, and to assure that citizens were not trying to avoid the tax, inspectors went from home to home to verify people were using sufficient amounts of the taxed oil. The Roman Empire over the years tried several types of taxes, including an inheritance tax (a tax on money one inherits from someone who has died), a sales tax, and taxes on imports (good sold to another country) and imports (goods purchased from another country). Governments sometimes chose tax methods because they were the easiest way to raise money given the circumstances of their countries and economies.

In the twentieth century the United States and many Western European countries experienced a substantial increase in tax rates. Governments began to take a more active role in trying to solve issues of poverty and income insecurity, and government spending came to be seen as a tool for stabilizing and stimulating an economy, especially when it was in a downturn. Also costly were two world wars (in 1914-18 and 1939-45) and the Cold War (after World War II, when the United States and the Soviet Union, each considering the other an enemy, spent vast amounts of money on their militaries). To pay for these added expenses, governments needed more money. For that they raised tax rates and invented new taxes. The tax burden in the United States went from about 6 percent of total income in 1900 to 34 percent in 2000.

More Detailed Information

In the United States people are taxed at the national, state, and local level. Therefore, people with the same income and spending habits might pay a different amount of tax per year depending on where they lived. They might also receive a different set of government benefits.

Everyone in the United States is subject to the same national tax laws, but that does not mean it is simple. The U.S. tax code, which explains the tax system of the national government, is more than 3 million words long. Because of the complexity of the tax code, many individuals and businesses employ accountants not only to ensure that are paying the correct amount and but also to avoid paying too much. The national government makes the most money on its income tax, which is an annual tax on a person’s income; it is progressive, meaning the more a person makes, the higher the tax rate, or percentage fee, on the income. Other important taxes include the payroll tax for Social Security (12.4 percent of one’s income, which goes largely to financing monthly payments to the elderly); corporate, or business, taxes; and excise taxes (which are taxes on a particular type of good, such as gasoline).

Although many states also have an income tax, the most important tax at the state level is usually the sales tax (as high as 7 percent in some states). Local governments—cities and counties, for example—rely heavily on the property tax, which is an annual tax on the value of a property, such as a house, land, and commercial property.

Recent Trends

Economists and political leaders have long argued over the various methods of taxation, as well as the effects of the total tax burden on the economy. In the United States, with the election of Ronald Reagan, the national government reduced the highest tax rate on income from 70 percent to 50 percent and later to just 28 percent. By 2001 the highest rate was back up to 35 percent. Although these changes seem substantial, tax revisions in the 1980s and 1990s were complicated. Although some taxes were reduced, others were increased, meaning that the burden of taxation shifted from one part of the population to another. Whatever true reductions in the overall tax burden that did exist had an unpleasant side effect. Because the government did not make corresponding cuts in government expenditures, the government began spending much more than it was receiving in taxes, increasing the government’s already sizable national debt.

Arguments over tax policy often centered on how taxes influenced economic efficiency and on different ideas of fairness. Some people believed a progressive income tax, in which wealthier people people paid a higher tax rate than others, was fair because some poor and even middle-class people had barely enough money to get by. Others argued that taxing different rates to different people was unjust, punishing wealthy people for succeeding in the economy, and that it led to various tax-avoidance behaviors that were harmful to the economy. Arguments were also fierce over the sales tax. Some people believed it was unfair because it was regressive—that is, because wealthy people tend to spend only a part of their income and to place the rest in savings or investments (which are not subject to the sales tax), wealthy people pay a smaller percentage of their income on sales taxes than other people. Those that defended the sales tax argued that it is a simple, less invasive form of taxation (the government does not have to collect information on the personal income of its citizens) and that the sales tax, because it applies only to purchases, encourages people to save, which has both social and economic benefits.