*** NOTE: Excerpted from the Academic American Encyclopedia (electronic) ***



TITLE(s):        income tax  
  The income tax is a levy based on the income of individuals, families, and
 corporations.                                                                
   
   The income tax is the largest source of tax revenue in advanced
 economies.  In the United States over half of the federal government's tax
 revenue comes from income taxes, with the personal income tax accounting for
 about 45% and the corporate income tax for another 10% of the total tax
 revenue.  Most individual states and some local governments also levy income
 taxes, but income taxes are less important than other sources of state tax
 revenue.                                                                     
    
  An income tax was first instituted in Britain on a permanent basis in
 1842.  The United States did not use an income tax until 1861, as a temporary
 measure to help finance the Civil War;  that tax was repealed in 1871.  When
 Congress tried to reinstate the income tax, the Supreme Court, in POLLOCK V.
 FARMERS' LOAN AND TRUST CO. (1895), declared that it was unconstitutional.   
    
  The 16TH AMENDMENT to the U.S. Constitution, ratified in 1913, consists of
 a single sentence that allows income taxation.  The 1913 income tax exempted
 the first $3,000 from taxation and taxed the remainder of income at graduated
 rates ranging from 1% for income up to $20,000 to as high as 7% for income
 over $500,000.  This was sufficiently high relative to income at the time
 that less than 1% of the population was subject to the  income tax then.     
    
  The initial passage of the law established a progressive tax structure,
 which means that taxpayers are taxed at a higher percentage rate the higher
 their incomes are.  A proportional tax would collect at the same percentage
 rate for all incomes, and a regressive tax collects a smaller percent of
 income for higher incomes.  The tax structure in the United States has
 remained progressive since the tax was established, although  specific rates
 have varied greatly.                                                         
    
  From an initial top rate of 7% in 1913, the top rate rose to 77% by 1918
 to help finance World War I.  The top rate fell to 25% from 1925 to 1928, but
 by 1936 had risen again to 78%.  The highest top bracket was 94% in 1944 and
 1945 to help finance World War II, and it remained above 90% in the early
 1960s until it was reduced to 70% by the tax act of 1964.  In 1981 the top
 rate was reduced to 50%, and it was reduced again by  the Tax Reform Act of
 1986.  Effective in 1991 the top rate was 31%.                               
    
  One of the most significant events in the history of the U.S. income tax
 was the introduction of withholding during World War II.  Prior to
 withholding, individuals were responsible for sending their tax payments to
 the government.  Withholding, however, requires employers to deduct a part of
 an employee's pay and send it directly to the government to cover the
 employee's estimated income taxes.  At the end of the year, the  income
 earner computes the income tax due and either pays any additional amount or
 receives a refund from the government for payments in excess of the tax due. 
 The withholding system makes it much easier for the government to collect
 taxes and makes evasion more difficult.                                      
    
  THE PERSONAL INCOME TAX 
    
  The amount of personal income tax due is computed in several steps. 
 First, total income from all sources is added together. Certain types of
 income are not included in income for tax purposes;  these are called
 exemptions.  Examples include a personal exemption for the taxpayer and for
 individuals who are supported by the taxpayer's income, and for employee
 business expenses such as the cost of travel for a traveling  salesperson. 
 Total income minus exemptions equals adjusted gross income.                  
    
  Taxpayers then subtract deductions from adjusted gross income to compute
 taxable income.  Items that can be deducted include home-mortgage interest
 payments and charitable contributions. In lieu of itemizing these deductions,
 taxpayers can choose to take a standard deduction;  exemptions, therefore,
 can be more valuable to taxpayers than deductions because exemptions can be
 taken even if other deductions are not itemized.                             
    
  The tax due is computed from taxable income according to the tax rate
 schedule.  An important concept in income taxation is the distinction between
 the average and marginal rates of taxation.  The average rate is the fraction
 of income paid in taxes.  The marginal rate is the fraction of any additional
 income that would have to be paid in taxes.  The average and marginal rates
 are not the same because, first, some income is  not taxed--due to
 exemptions, deductions, and credits;  and, second, the progressive tax
 schedule taxes lower levels of income at a lower rate than higher levels of
 income.                                                                      

  The Tax Reform Act of 1986 simplified the tax structure and reduced the
 total number of tax brackets to four. Lowest-income taxpayers had an income
 tax rate of 15%, and as income rose, the marginal tax rate rose to 28%, then
 to 33%, and then back down to 28%.  For the first time in the history of the
 income tax, the taxpayers with the highest incomes were not in the highest
 tax bracket.  In 1991 the two top brackets  were combined and the tax rate
 for that bracket was set at 31 percent.  This reduced the number of tax
 brackets to three, with marginal tax rates of 15, 28, and 31%.               
    
  The complexities of the tax code are the result of the attempt to achieve
 a number of goals in its design.  The first goal is fairness, and, with the
 income tax, fairness is generally interpreted to mean that taxpayers should
 be taxed in proportion to their ability to pay.  In trying to implement the
 ability-to-pay principle, the tax code taxes single taxpayers more than
 married taxpayers with nonworking spouses, but taxes  married couples who
 both work more than if they both were single.  Families with children also
 pay less in an attempt to tax the same amount for those with equal abilities
 to pay.  The progressive nature of the tax code implements the ability-to-pay
 principle by suggesting that those with more income have a
 more-than-proportional ability to pay.  How progressive the tax code should
 be, however, is a matter of  debate.                                         
    
  A second goal of the tax code is efficiency, which means collecting a
 given amount of tax revenue at the least cost. The efficiency of the tax is
 affected by the costs of collection, such as the cost of filling out forms,
 having the government monitor payments, and so on.  Efficiency is also
 influenced by the incentives that an income tax introduces against earning
 taxable income.  Higher tax rates provide an  incentive for taxpayers to work
 less to do their own work rather than hire someone else who will have to pay
 income tax, and to cheat by not reporting income.  These incentives can be
 minimized by keeping tax rates low, so the goal of efficiency conflicts with
 the equity goal of progressive taxation.                                     
    
  Historically, the tax code has also been used to further other goals by
 providing tax incentives.  Home-mortgage interest can be deducted from
 taxable income, creating an incentive for home ownership.  Charitable
 contributions can be deducted, providing an incentive for charitable giving. 
 The use of the tax system to provide these kinds of incentives is
 controversial, and the Tax Reform Act of 1986 eliminated many incentives of
 this type.                                                                   

  THE CORPORATE INCOME TAX 
    
  In 1960 the corporate income tax comprised 23.2% of federal tax revenues,
 but had fallen to 12.5 percent of federal tax revenues by 1980, due to the
 effects of tax reform undertaken in the 1960s and 1970s.  The decline
 resulted from corporations being able to shelter more income from taxation
 through credits, exemptions, and deductions.  Because of the 1981 tax reform,
 corporate income tax collections made up only 6.2% of  federal tax revenues
 in 1983, in large part because the 1981 tax act allowed more favorable
 treatment of depreciation.  The Tax Reform Act of 1986 contained measures to
 increase the contribution of corporate income taxes to total federal taxes,
 and by 1989 corporate income tax collections made up more than 11% of federal
 tax revenue.                                                                 
    
  Taxable income for corporations is computed by subtracting allowable
 expenses from income, but from 1960 to the mid-1980s a greater range of
 expenses was being allowed.  An investment tax credit allowed the reduction
 of tax payments by 10% of investment expenditures, and firms were permitted
 to write off large depreciation expenses to lower their taxes.  The Tax
 Reform Act of 1986 reduced corporate income tax rates, but  corporations must
 pay taxes on more of their income, since less can be deducted.  As a result,
 corporate income tax collections as a share of total federal taxes have
 increased by more than 80 percent.                                           
    
  One controversy regarding corporate tax rates is who actually ends up
 paying the tax.  Corporations may raise their prices to cover the corporate
 income taxes they pay, which would mean that the tax is actually paid by the
 corporation's customers rather than by the corporation itself.  If the
 corporation did not raise its prices to cover the tax, then the tax would
 lower corporate profits, so that the stockholders of the corporation  would
 end up paying the tax.  Since insurance companies and pension plans own large
 blocks of stock, the corporate income tax may fall heavily on those
 industries and their customers. Economists agree that the tax is ultimately
 paid from all of these groups, but there is no agreement on who pays how
 much.                                                                        
    
  Another controversy regarding the corporate income tax is the issue of
 double taxation.  A tax on corporate income taxes the stockholder several
 times because corporations pay income tax on the money they pay out as
 dividends and then the recipient of the dividend must pay personal income tax
 on the dividend. Furthermore, stock is bought with after-tax income, then,
 when the stockholder is paid a dividend from the corporation or  sells the
 stock at a profit, the income earned is taxed again. Some people argue that
 corporate income should not be taxed in order to avoid double taxation, while
 others argue that those who earn corporate income can best afford to pay
 taxes.  The question is closely related to the issue of who ultimately pays
 the corporate income tax, since corporations really only collect taxes that
 are paid by individual stockholders and  customers.                          
    
  TAX POLICY AND TAX REFORM 
    
  Originally, the income tax was seen solely as a method of raising revenue,
 but since World War II it has been used as a tool for furthering other goals
 as well.  In 1964 a tax cut designed by Presidents Kennedy and Johnson was
 enacted to help the sagging economy.  The logic was that a tax cut would give
 consumers more money to spend, which would stimulate business activity.  This
 was the first time that income tax reform was  undertaken primarily to try to
 fine-tune the economy.                                                       

  President Kennedy also instituted the investment tax credit to encourage
 investment, and throughout the 1960s and 1970s many other tax benefits were
 added to the tax system.  Among them were oil depletion allowances that made
 oil exploration more profitable, an energy tax credit that provided an
 incentive for energy-efficient investment, and tax exemptions under certain
 conditions for retirement savings and health insurance.  Each  change, taken
 by itself, had an individual rationale, but the cumulative effect of such
 reforms was to reduce the amount of income subject to taxation, which
 required higher average rates to raise the same amount of revenue.           
    
  Throughout the 1960s and 1970s inflation had the effect of continually
 pushing taxpayers into higher income tax brackets, which provided additional
 revenue to compensate for the increase in tax benefits.  Inflation provided
 enough additional revenue that rate reductions to partially offset the
 effects of inflation were also common.  The 1981 tax reform act contained a
 provision to automatically index tax brackets to offset  inflation, making
 this type of tax reform unnecessary.                                         
    
  The Tax Reform Act of 1986 was the most comprehensive change in the
 structure of the U.S. income tax since it was enacted. The cumulative effect
 of many small tax reforms over the preceding several decades was to increase
 the number of deductions, credits, and exemptions, which resulted in less
 income being subject to taxation.  The 1986 reform was designed to lower tax
 rates while collecting about the same amount of  revenue, by eliminating most
 tax preferences and thus increasing the amount of income that could be taxed.
  Reduced tax rates also have the advantages of increasing the incentive to
 earn income, while lowering the incentive for taxpayers to look for tax
 shelters to avoid taxation.  One measure of the success of the 1986 tax
 reform is that only minor changes were made to the income tax structure in
 the five years following  that reform.                                       
    
  Randall G. Holcombe  

  Bibliography:  Bradford, D. F., Untangling the Income Tax (1986);  Davies,
 David G., United States Taxes and Tax Policy (1986);  Hall, Robert E., and
 Rabushka, Alvin, The Flat Tax (1985);  Holcombe, Randall G., Public Sector
 Economics (1988); Peacock, Alan, and Forte, Frances, eds., The Political
 Economy of Taxation (1981);  (1985);  Strassels, Paul N., The 1986 Tax Reform
 Act (1987).                                                                  




TITLE(s):        Treasury, U.S. Department of the  
  The U.S. 
   
  Department of the Treasury is the department of the executive branch of
 government that oversees the nation's finances.  The department was created
 in 1789, and its first secretary was Alexander Hamilton. The secretary of the
 treasury is the second-ranking officer (after the secretary of state) in the
 president's cabinet.  The secretary is the president's chief advisor on
 fiscal affairs and is responsible for managing the public debt.  The law 
 requires the secretary to report each year to the Congress on the
 government's fiscal operations and its financial condition. The secretary is
 also involved in financial dealings with other nations.  The secretary has
 special staffs dealing with such matters as defense lending, debt analysis,
 financial analysis, international finance, international tax affairs, and
 law-enforcement coordination.                                                
    
  The Treasury Department's operating bureaus include the COMPTROLLER OF THE
 CURRENCY, who supervises national banks; the United States Customs Service,
 which collects taxes on goods brought into the country from abroad; the
 Bureau of Engraving and Printing, which produces currency, bonds, Federal
 Reserve notes, and postage stamps; the Bureau of Government Financial
 Operations, which is responsible for the government's cash  management
 program and central accounting and reporting system; the Bureau of the Public
 Debt; the INTERNAL REVENUE SERVICE, which collects taxes; the United States
 Mint, which manufactures coinage; the Bureau of Alcohol, Tobacco and
 Firearms, which enforces federal laws on production, use and distribution;
 and the SECRET SERVICE, which protects top U.S. officials and presidential
 candidates and enforces laws against  counterfeiting.                        

  Bibliography:  Adams, S., The United States Treasury System (1979); 
 Gaines, Tilford C., Techniques of Treasury Debt Management (1962);  Gurney,
 Gene and Clare, The United States Treasury:  A Pictorial History (1977); 
 Taus, Esther R., Central Banking Functions of the United States Treasury,
 1789-1941 (1943;  repr. 1966);  Walston, M., The Department of the Treasury
 (1989).                                                                      


TITLE(s):        Internal Revenue Service  
  The U.S. government's tax collecting agency, the Internal Revenue Service,
 was created in 1862.                                                         
   
   However, it did not assume its present shape until the federal power to
 tax incomes was sanctioned by the 16TH AMENDMENT (1913) and revenues
 increased enormously after World War II.  The IRS, a division of the
 Department of the Treasury, administers all of the internal revenue laws
 except those relating to alcohol, tobacco, firearms, and explosives;  its
 most important assignments are to collect personal and corporate INCOME
 TAXES,  SOCIAL SECURITY taxes, and excise, estate, and gift taxes.           
    
  The IRS seeks to obtain voluntary compliance with the tax laws as far as
 possible.  To this end it stresses communication with taxpayers by providing
 assistance and information for those who need it.  Most of the approximately
 118,000 employees of the IRS work in field offices throughout the country. 
 There are 7 regions, each headed by a regional commissioner, and 64 districts
 administered by district directors.  Tax returns are  processed in separate
 tax service centers.  The national office in Washington, D.C., develops
 policies and supervises the field organization.                              
    
  By the early 1980s the IRS was confronting increasing tax evasion and
 taxpayer resistance, fueled by perceptions that the tax laws were unfair and
 administered unfairly.  The IRS must interpret the tax laws through the
 regulations it issues, although the IRS is not responsible for writing the
 laws themselves.  Despite a massive overhaul of the tax system in 1986, the
 IRS's interpretations are regularly challenged in  cases brought to the U.S.
 TAX COURT;  and, in adjudication, IRS tax assessments are sometimes rejected.
  It is, however, often possible for businesses and individuals to negotiate
 settlements directly with the IRS.                                           
    
  Another source of taxpayer unhappiness is the complexity of many of the
 tax forms.  They are often so cumbersome and difficult to understand that
 ordinary taxpayers may require the services of an accountant merely to file a
 tax return.                                                                  
    
  In its efforts to discover tax evaders, the IRS has invested in
 computerized systems that allow it to gather information from many different
 sources and match it with data in its own files, in order to root out, for
 example, individuals whose life-styles indicate larger incomes than their tax
 returns list.  Thus, the IRS can collect information from the 50 states on
 automobile and boat registration, professional licenses  issued, and business
 activities that require state permits.  It has also attempted to buy
 computerized lists from private marketing organizations.  Such activities
 have raised questions relating to the issue of invasion of privacy.          
    
  IRS information has been used by other state and government agencies.  In
 most cases--the enforcement of child-support laws, for example, or the
 attempt to find those who have defaulted on student loans--the disclosure of
 information has been authorized by Congress.                                 

  Bibliography:  Burnham, David: A Law unto Itself: Power, Politics, and the
 IRS (1990);  Saltzman, Michael, IRS Practice and Procedures (1981); 
 Shafiroff, I., Internal Revenue Service Practice and Procedure Deskbook, 2d
 ed. (1989).                                                                  



TITLE(s):        Tax Court, U.S.  
  The United States Tax Court is a court of the federal government that
 hears cases brought by taxpayers who challenge decisions of the Internal
 Revenue Service (IRS) dealing with overpayment or underpayment of taxes.     
   
   In many instances the decisions of the U.S. Tax Court can be appealed to
 the U.S. Court of Appeals and ultimately to the Supreme Court.  When
 taxpayers exercise an option to agree to the use of simplified court
 procedures in disputes involving $10,000 or less, however, the cases tried
 under these procedures cannot be appealed to a higher court.  The U.S. Tax
 Court also decides disputes over the rights of taxpayers to see documents and
  other materials that are related to their cases and that are contained in
 IRS files.                                                                   
    
  The court is composed of 19 judges appointed for life and 17 special trial
 judges appointed by the chief judge who serve at the pleasure of the court. 
 It is augmented by retired judges when the case load is heavy.  The court's
 offices are in Washington, D.C., but it maintains a field office in Los
 Angeles and holds trial sessions throughout the United States.               

  Bibliography:  Taylor, M. W., and Simonson, K. J., Tax Court Practice, 7th
 ed. (1990).                                                                  

