Agribusiness Library LESSON L060092: ANALYZING THE UNITED STATES TAX SYSTEM

Objectives 1. List and describe the types of taxes imposed at the local, state, and/or federal level. 2. Examine the history of the U.S. Tax system. 3. Identify the levels of government that impose taxes, and determine how those taxes are utilized. 4. Determine the general principles of good tax policy, and define various tax types.

Terms Capital gains tax Direct tax Estate tax Excise tax Federal insurance contributions act tax Gift tax Income tax Indirect tax Internal revenue service Medicare

Terms Progressive tax Property tax Regressive tax Sales tax Social security Tariff Tax

 A tax is a required payment imposed on items (e.g., income, property, or purchases) and paid to a local, state, or federal government entity.  Local, state, and federal governments utilize tax money to carry out government functions and to provide services to the public.  Public education, national defense, road construction and maintenance, and law enforcement are a few examples.  These services are made possible by generating revenue through levying taxes on citizens.  The following are examples of the most common types of taxes levied at the local, state, and federal levels: income, FICA, property, sales, excise, estate, gift, capital gains, and tariff.

 A. Income tax: Income taxes are the main revenue source for the federal government and most state governments.  An income tax is a levy on the taxable income (net earnings) of individuals, partnerships, corporations, or other entities.  The income tax levied on companies taxes the company’s net profit and is often referred to as the corporate income tax.  B. FICA tax: The Federal Insurance Contributions Act (FICA) tax is a tax levied by the federal government to finance Social Security and Medicare.  1. Social Security is a federal government program that provides workers with retirement income, unemployment benefits, and disability benefits.  2. Medicare is a federal health insurance program for people 65 years of age or older or for individuals under 65 years of age with certain disabilities.

 C. Property tax: A property tax is a tax levied on real estate, which includes land and permanent improvements made to land (e.g., buildings).  In some states, personal property (e.g., automobiles, machinery, and boats) is also taxed.  Property taxes are the primary income source of revenue for counties, cities, and school districts.  As a result, property taxes supply the necessary revenue to offer valuable local services, such as the maintenance of roads and streets, police and fire protection, and public education.

 D. Sales tax: A sales tax is a tax levied by a state, county, and/or city on the price of goods or services purchased by consumers.  Most, but not all, states collect a sales tax, with rates ranging from 3.5 to 7.25 percent of the purchased price of a good or service.  In addition to the state sales tax, a city or county sales tax may be added to the purchase price.  E. Excise tax: An excise tax is a tax imposed on the purchase of certain goods, such as gasoline, alcohol, and tobacco.  Typically, the purpose of an excise tax is to discourage a particular behavior.  For example, a tax on tobacco is intended to raise the price of cigarettes or other tobacco products to a level that will discourage their use.

 F. Estate and gift taxes  1. The estate tax, as defined by the Internal Revenue Service, is a tax on your right to transfer property at your death.  Property eligible for the estate tax includes cash, real estate, trusts, annuities, or other assets.  Estate taxes are filed only if gross assets exceed $3.5 million; therefore, the estate tax only affects the wealthiest 2 percent of Americans.  2. The gift tax is a tax on the property that a living individual gives to another while receiving nothing, or less than full value, in return.  The gift tax was implemented to stop citizens from transferring wealth prior to death to avoid the estate tax.

 G. Capital gains tax: The capital gains tax is a federal tax imposed on profits from the sale of a capital asset (e.g., a house, land, machinery, equipment, stocks, and bonds).  Net capital gain is usually taxed at 10 to 15 percent, but exceptions do exist.  H. Tariff: A tariff is a federal tax imposed on imported goods.  Tariffs were the primary source of federal revenue from the inception of the United States until the eve of World War I when it was surpassed by the income tax.  With the passage of free trade agreements (e.g., the North American Free Trade Agreement and the Free Trade Area of the Americas), tariffs rarely exist in the United States.

 When the United States became a nation, the federal government possessed very few responsibilities and did not have a nationwide tax system.  Instead, the federal government relied on donations from the states for revenue.  It was not until the Constitution was adopted in 1789 that the federal government (through Congress) was given the power to “lay and collect taxes, duties…pay the Debts and provide for the common Defense and general Welfare of the United States.”

 A. During the early years in the United States, the country collected revenue through excise taxes, customs duties, the sale of Treasury notes, and the sale of public land.  1. The individual income tax was not imposed until the Revenue Act of 1862 was passed, which was during the Civil War.  2. The Revenue Act of 1862 also created the office of the Commissioner of Internal Revenue, which eventually became the Internal Revenue Service.  The Internal Revenue Service (IRS) is a federal agency within the U.S. Department of the Treasury that is responsible for collecting taxes and enforcing tax laws.

 B. The income tax was challenged and was ruled unconstitutional in  It was not reinstituted until  1. In 1913, the 16th amendment to the Constitution was ratified.  It provided Congress with the authority to collect taxes on incomes.  2. Income tax rates ranged from 1 to 7 percent for taxpayers with income of more than $500,000.

 C. World War I created a need for additional revenue.  1. In 1916, Congress raised the lowest income tax rate from 1 to 2 percent and raised the top rate to 15 percent.  2. In 1917, income taxes were increased again.  3. Then income tax rates were raised again in  The bottom rate was increased to 6 percent, and the top rate was increased to 77 percent.  4. Income taxes were reduced in the 1920s, but they were increased in 1932 and in 1936.

 D. In 1935, the Social Security Act was passed in response to the poor economy during the Great Depression.  The Social Security Act provided payments to the:  1. Elderly  2. Unemployed  3. Needy  4. Handicapped

 E. As defense spending increased prior to the United States entering World War II, the need for additional revenue was resolved by changing the income tax dramatically.  As a result, the number of income taxpayers increased from 4 million in 1939 to 43 million in  Once again, rates were increased.  F. Relatively minor adjustments were made to the taxes in the United States, until 1981 when the Economic Recovery Tax Act was passed.  This resulted in a 25 percent reduction in individual tax brackets and reduced the top tax bracket to 50 percent.

 Local, state, and federal governments impose taxes to receive the revenue necessary to carry out government functions and to provide services to the public.  However, each level of government imposes different types of taxes and provides different types of services to citizens.  A. At the local level, property taxes typically provide the primary source of revenue.  1. In addition to property taxes, some cities, counties, and school districts levy a sales tax to generate additional funds.  2. The revenues received are utilized to provide services (e.g., maintenance of streets and roads, snow removal from streets, sewer service, police and fire protection, public K–12 education, maintenance and operation of parks, and maintenance and operation of libraries).

 B. At the state level, the income tax is the primary source of revenue for most states.  1. Some states also levy sales taxes or excise taxes and charge other miscellaneous fees to generate revenue.  2. The revenue generated is used for a variety of purposes, but it may include expenditures on items such as K–12 and higher education, public health, veteran’s affairs, law enforcement, the correctional system, environmental protection, or the judicial system.

 C. At the federal level, the income tax is the primary source of revenue.  1. The federal government also imposes other taxes, such as the excise, estate, gift, capital gains, and FICA taxes.  2. The revenue generated by the federal government is spent on a wide assortment of things, but the major expenditures are for the Department of Defense, Social Security, Medicare, and interest on the national debt.

 Many different opinions exist regarding the principles of a good tax policy for local, state, or federal governments.  However, regardless of personal perspective, most would agree that taxes should be fair and reasonable, should promote economic growth, should not interfere with the decisions of people in a free-market economy, should provide relatively stable income even during poor economic cycles, and should be simple enough that taxpayers can understand the rules.

 In addition, tax policies should rarely change so that long-term planning by individuals and corporations can occur.  In addition, most citizens would prefer a progressive tax system over a regressive tax system and, depending upon their perspective, may prefer to pay direct taxes over indirect taxes.

 A. Progressive and regressive tax  1. A progressive tax is a tax that imposes a higher tax rate as the taxable amount increases.  a. The U.S. income tax is an example of a progressive tax as high-income earners pay a higher income tax rate than low- income earners.  b. For example, in 2009, individuals who earn more than $372,951 pay a 35 percent tax rate.  In contrast, individuals who earn less than $33,950 pay no more than a 15 percent tax rate.  2. A regressive tax is the opposite of a progressive tax; it imposes a lower tax rate as the taxable amount increases.  Sales tax on food or other necessities can be considered a regressive tax as low-income earners pay a higher percentage of their earnings on the tax than do high-income earners.

 B. Direct and indirect taxes  1. A direct tax is a tax that people pay straight to the government.  Examples of direct taxes include income and property taxes.  2. An indirect tax is a tax that people do not pay directly, but it is passed on to them through higher prices (on items purchased) due to taxes on businesses.  a. For example, tariffs on imported goods are paid by businesses, but the consumers who purchase the imported products pay higher prices as a result of the tariffs.  b. Sales taxes can be considered an indirect tax because individuals typically do not realize how much they spend over a period of a year on sales taxes.

REVIEW What are the types of taxes imposed at the local, state, and federal level? What are the major events in U.S. History related to taxes? How do local, state, and federal government agencies utilize tax dollars? What are the general principles of good tax policy? What are some tax types?