Skip to main content
Social Sci LibreTexts

16.4: Taxation in the United States

  • Page ID
    3536
  • [ "article:topic", "fiscal policy", "balanced budget", "sales tax", "income tax", "property tax", "authorname:boundless" ]

    Financing the US Government

    Taxes are the primary source of government revenue.

    learning objectives

    • Identify the basis for taxation.

    Financing of Government Expenditures

    Taxation is the central part of modern public finance. The importance of taxation arises from the fact that it is by far the most significant source of government revenue and is therefore the primary means of financing government expenditures.

    irs-sign.jpg 

    Taxation authority: In the United States the Internal Revenue Service is the regulatory authority empowered by Congress to collect taxes.

    Due to the pervasive nature of taxation, taxes can be used as an instrument of attaining certain social objectives. For example, income taxes due to their progressive nature are used to equitably derive revenue by differentiating tax rates by income strata. The income derived in this manner is then used to transfer income to lower income groups, thereby, reducing inequalities related to income and wealth.

    Taxation is also used as part of fiscal policy to stabilize the economy. Increasing taxes can reduce consumption and lead to economic slowing when the economy may be growing too quickly. Alternatively, decreasing taxes can be a mechanism to promote economic growth by increasing the funds available for consumption and investment spending. It is important to note that when the government spends more than the tax revenue it collects, the government is operating at a deficit and will have to borrow funds to finance operations until taxes can be increased to return the government spending to a balanced budget.

     

    Types of Taxes

    The US government imposes a number of different types of taxes in order to finance its operations. The following is a list of taxes in common use by governmental authorities:

    • Excise tax: tax levied on production for sale, or sale, of a certain good.
    • Sales tax: tax on business transactions, especially the sale of goods and services.
    • Corporate income tax: tax on a company’s profits.
    • Income tax: tax on an individual’s wages or salary.
    • Capital gains tax: tax on increases in the value of owned assets.

    Financing State and Local Government 

    Taxes are the primary source of revenue for state and local governments; income, property, and sales taxes are common examples of state and local taxes.

    learning objectives

    • Give an example of federal, state, and local taxes

    Taxes are important to federal, state, and local governments. They are the primary source of revenue for the corresponding level of government and fund the activities of the governmental entity. For example, on a local level, taxes fund the provision of common services, such as police or fire department, and the maintenance of common areas, such as public parks. On a state level, taxes fund the school systems, including state universities. On a federal level, taxes are used to fund government activities such as the provision of welfare and transfer payments to redistribute income.

    state-park-2c-townsend-ma.jpg 

    Pearl Hill State Park: State parks like Pearl Hill, located in Townsend, Massachusetts, rely on tax revenue for support and maintenance.

    Example of a Federal, State, and Local Tax

    Income taxes are taxes imposed on the net income of individuals and corporations by the federal, most state, and some local governments. State and local income tax rates vary widely by jurisdiction and many are graduated, or increase progressively as income levels increase. State taxes are generally treated as a deductible expense for federal tax computation.

    Example of a State Tax

    Sales taxes are imposed by most states on the retail sale price of many goods and some services. Sales tax rates also vary widely among jurisdictions, from 0% to 16%, and may vary within a jurisdiction based on the particular goods or services taxed. Sales tax is collected by the seller at the time of sale, or remitted as use tax by buyers of taxable items who did not pay sales tax.

    Example of a Local Tax

    Property taxes are imposed by most local governments and many special purpose authorities based on the fair market value of property. Property tax is generally imposed only on real estate, though some jurisdictions tax some forms of business property. Property tax rules and rates vary widely.

    Key Points

    • Taxes can be used to stabilize the economy.
    • The implementation of taxes can promote social equity; for example the use of progressive income taxes.
    • There are many types of taxes that can be legislated to derive revenue for government operations.
    • State and local governments collect taxes from residents to support corresponding state and local government activities. Examples of these services include maintenance of public parks and provision of a police force.
    • Property tax is an example of a local tax. It is imposed on the value of real estate.
    • Sales tax may be imposed by both a state and local government. It is charged at the point of sale of the good or service.
    • Income tax may be imposed by the federal, state, or local government. Tax rates vary by location, and often by income level.

    Key Terms

    • balanced budget: A (usually government) budget in which income and expenditure are equal over a set period of time.
    • fiscal policy: Government policy that attempts to influence the direction of the economy through changes in government spending or taxes.
    • sales tax: A local or state tax imposed as a percentage of the selling price of goods or services payable by the customer. The tax is not recognized as the seller’s earnings; the seller only collects the tax and transmits the same to local or state authorities.
    • property tax: An (usually) ad valorem tax charged on the basis of the fair market value of property.
    • income tax: A tax levied on earned and unearned income, net of allowed deductions.

     

    LICENSES AND ATTRIBUTIONS

    CC LICENSED CONTENT, SPECIFIC ATTRIBUTION