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taxes

“In this world, nothing can be said to be certain, except death and taxes.” So wrote Benjamin Franklin, American statesman, in 1789. To this day the rhetoric regarding taxes often overshadows the reality of an immensely complex system of federal, state and local taxation. Taxes, the nearly inevitable result of civilized society, support numerous purposes. They raise revenue for government expenditures, redistribute wealth, and provide economic stability. Taxes play a predominant role in American political dialogue through their creation, implementation and impact. Strong disagreement exists over the role that taxes, and the governments that levy them, should play in the US.

As a percentage of national income, personal income taxes are 12.3 percent. The percentages for social insurance taxes, sales/excise taxes, corporate taxes and property taxes, are 10.4 percent, 4.9 percent, 3.6 percent and 3.3 percent respectively. At the federal level 67.4 percent of taxes are collected, with the remainder going to state and local authorities. Social-insurance taxes finance retirement and health benefits. Benefits are distributed in proportion to the taxes paid during one’s working years. Financial difficulties confronting the system aside, it is essentially a forced savings plan. Sales and property taxes are collected at the state (or local) level as an alternative to income taxes.

In 1994 such taxes accounted for over half of state and local revenues. Delaware, the “Home of Tax-Free Shopping,” is one of five states without a sales tax. These states compensate with higher income taxes, use taxes or reduced services. Just 9 percent of US businesses are subject to corporate income tax, normally at a rate of 35 percent. The effective rate is significantly lower due to numerous credits, deductions and depreciation allowances.

When Americans speak of taxes, however, they typically refer to personal income taxes. First imposed during the Civil War, income tax became permanent in 1913, after ratification of the 16th Amendment to the Constitution. Income tax was an appealing alternative to tariffs, excise taxes and property taxes that were regressive in nature. The first income tax was aimed at the very rich. Fewer than one percent of citizens filed returns. Personal income taxation played a small role until just before the Second World War, when exemptions were reduced and tax rates increased to finance wartime production. By this time, one-third of the population was responsible for some tax.

The progressive spirit of the tax code burdens the wealthy with additional responsibilities to pay for the services that contributed to their wealth. Marginal tax rates provided for low rates at low-income levels. As income increases, tax rates increase as well, with each additional dollar of income taxed at one’s highest rate. The post-Second World War period saw the top marginal rate slide from a growth-impeding 94 percent in 1944–5 to 70 percent through the 1970s. Tax reform focusing on the Laffer Curve and supplyside economics, which argued that low tax rates increase tax revenues by increasing total economic output, led to a top rate of 28 percent by 1988.

While progressive in spirit, loopholes have developed over the life of the tax code to the point that wealthy families deduct significant portions of income. Charitable exclusions, exclusions for government-bond interest and generation-skipping trusts are common tax-avoidance techniques. Middle-class taxpayers, often the most vocal taxreform advocates, benefit from the largest deduction of all—the ability to exclude mortgage interest paid from taxes.

Income taxes are collected by the Internal Revenue Service (IRS). Tax returns are filed annually but paid primarily from paycheck withholding. As the deadline, April 15 approaches, media depictions of Americans rushing to complete complicated paperwork and figure out how to afford the bill grow abundant. The IRS uses the fear of audits (fewer than 2 percent of returns are audited), information reporting from employers and tax withholding to enforce tax laws. Even so, $150 billion in revenue is lost to noncompliance.

The IRS has developed a reputation for poor service and predatory collection practices, which it addressed in the 1990s with customer-service initiatives.

Americans tend to share a general antipathy for taxes. There are two primary explanations for anti-tax sentiment. The attitude of “everybody wants everything and nobody wants to pay for it” provides an explanation for tax hatred without theoretical basis. On the other hand, general opposition to the size, motivation and goals of government provide a strong base of support for tax reform.

There are numerous advocacy groups that support tax cuts and reforms. The Tax Foundation annually calculates a “Tax Freedom Day.” In 1998, “Tax Freedom Day” was May 10, meaning that Americans spent 35.4 percent of the year earning money to pay various taxes. In general, taxes have risen with “Tax Freedom Day” occurring on February 12 (1930), April 15 (1960) and May 1 (1990). Tax is also a strong feature of Republican political rhetoric.

The implication from the above is that Americans pay too much in taxes. In fact, the US has lower taxes than the majority of economically developed countries. A 1993 study indicates that US taxes are equal to 29.7 percent of GDP. Only Japan had a lower rate, with the United Kingdom (33.6), Germany (39.0) and Sweden (49.9) shouldering significantly higher burdens (Slemrod and Bakija 1996:20). While personal and corporate income taxes are similar across countries, the US has far lower sales and value-added taxes than other nations.

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