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<xml><p>*** NOTE: Excerpted from the Academic American Encyclopedia (electronic) ***</p>
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<p>TITLE(s): income tax
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The income tax is a levy based on the income of individuals, families, and
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corporations.
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The income tax is the largest source of tax revenue in advanced
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economies. In the United States over half of the federal government's tax
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revenue comes from income taxes, with the personal income tax accounting for
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about 45% and the corporate income tax for another 10% of the total tax
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revenue. Most individual states and some local governments also levy income
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taxes, but income taxes are less important than other sources of state tax
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revenue.
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An income tax was first instituted in Britain on a permanent basis in
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1842. The United States did not use an income tax until 1861, as a temporary
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measure to help finance the Civil War; that tax was repealed in 1871. When
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Congress tried to reinstate the income tax, the Supreme Court, in POLLOCK V.
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FARMERS' LOAN AND TRUST CO. (1895), declared that it was unconstitutional.
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The 16TH AMENDMENT to the U.S. Constitution, ratified in 1913, consists of
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a single sentence that allows income taxation. The 1913 income tax exempted
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the first $3000 from taxation and taxed the remainder of income at graduated
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rates ranging from 1% for income up to $20000 to as high as 7% for income
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over $500000. This was sufficiently high relative to income at the time
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that less than 1% of the population was subject to the income tax then.
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The initial passage of the law established a progressive tax structure,
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which means that taxpayers are taxed at a higher percentage rate the higher
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their incomes are. A proportional tax would collect at the same percentage
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rate for all incomes, and a regressive tax collects a smaller percent of
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income for higher incomes. The tax structure in the United States has
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remained progressive since the tax was established, although specific rates
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have varied greatly.
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From an initial top rate of 7% in 1913, the top rate rose to 77% by 1918
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to help finance world war I. The top rate fell to 25% from 1925 to 1928, but
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by 1936 had risen again to 78%. The highest top bracket was 94% in 1944 and
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1945 to help finance World War II, and it remained above 90% in the early
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1960s until it was reduced to 70% by the tax act of 1964. In 1981 the top
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rate was reduced to 50%, and it was reduced again by the Tax Reform Act of
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1986. Effective in 1991 the top rate was 31%.
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One of the most significant events in the history of the U.S. income tax
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was the introduction of withholding during World War II. Prior to
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withholding, individuals were responsible for sending their tax payments to
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the government. Withholding, however, requires employers to deduct a part of
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an employee's pay and send it directly to the government to cover the
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employee's estimated income taxes. At the end of the year, the income
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earner computes the income tax due and either pays any additional amount or
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receives a refund from the government for payments in excess of the tax due.
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The withholding system makes it much easier for the government to collect
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taxes and makes evasion more difficult.
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THE PERSONAL INCOME TAX
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The amount of personal income tax due is computed in several steps.
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First, total income from all sources is added together. Certain types of
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income are not included in income for tax purposes; these are called
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exemptions. Examples include a personal exemption for the taxpayer and for
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individuals who are supported by the taxpayer's income, and for employee
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business expenses such as the cost of travel for a traveling salesperson.
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Total income minus exemptions equals adjusted gross income.
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Taxpayers then subtract deductions from adjusted gross income to compute
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taxable income. Items that can be deducted include home-mortgage interest
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payments and charitable contributions. In lieu of itemizing these deductions,
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taxpayers can choose to take a standard deduction; exemptions, therefore,
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can be more valuable to taxpayers than deductions because exemptions can be
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taken even if other deductions are not itemized.
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The tax due is computed from taxable income according to the tax rate
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schedule. An important concept in income taxation is the distinction between
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the average and marginal rates of taxation. The average rate is the fraction
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of income paid in taxes. The marginal rate is the fraction of any additional
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income that would have to be paid in taxes. The average and marginal rates
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are not the same because, first, some income is not taxed--due to
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exemptions, deductions, and credits; and, second, the progressive tax
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schedule taxes lower levels of income at a lower rate than higher levels of
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income. </p>
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<p> The Tax Reform Act of 1986 simplified the tax structure and reduced the
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total number of tax brackets to four. Lowest-income taxpayers had an income
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tax rate of 15%, and as income rose, the marginal tax rate rose to 28%, then
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to 33%, and then back down to 28%. For the first time in the history of the
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income tax, the taxpayers with the highest incomes were not in the highest
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tax bracket. In 1991 the two top brackets were combined and the tax rate
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for that bracket was set at 31 percent. This reduced the number of tax
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brackets to three, with marginal tax rates of 15, 28, and 31%.
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The complexities of the tax code are the result of the attempt to achieve
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a number of goals in its design. The first goal is fairness, and, with the
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income tax, fairness is generally interpreted to mean that taxpayers should
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be taxed in proportion to their ability to pay. In trying to implement the
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ability-to-pay principle, the tax code taxes single taxpayers more than
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married taxpayers with nonworking spouses, but taxes married couples who
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both work more than if they both were single. Families with children also
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pay less in an attempt to tax the same amount for those with equal abilities
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to pay. The progressive nature of the tax code implements the ability-to-pay
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principle by suggesting that those with more income have a
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more-than-proportional ability to pay. How progressive the tax code should
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be, however, is a matter of debate.
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A second goal of the tax code is efficiency, which means collecting a
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given amount of tax revenue at the least cost. The efficiency of the tax is
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affected by the costs of collection, such as the cost of filling out forms,
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having the government monitor payments, and so on. Efficiency is also
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influenced by the incentives that an income tax introduces against earning
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taxable income. Higher tax rates provide an incentive for taxpayers to work
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less to do their own work rather than hire someone else who will have to pay
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income tax, and to cheat by not reporting income. These incentives can be
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minimized by keeping tax rates low, so the goal of efficiency conflicts with
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the equity goal of progressive taxation.
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Historically, the tax code has also been used to further other goals by
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providing tax incentives. Home-mortgage interest can be deducted from
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taxable income, creating an incentive for home ownership. Charitable
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contributions can be deducted, providing an incentive for charitable giving.
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The use of the tax system to provide these kinds of incentives is
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controversial, and the Tax Reform Act of 1986 eliminated many incentives of
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this type. </p>
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<p> THE CORPORATE INCOME TAX
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In 1960 the corporate income tax comprised 23.2% of federal tax revenues,
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but had fallen to 12.5 percent of federal tax revenues by 1980, due to the
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effects of tax reform undertaken in the 1960s and 1970s. The decline
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resulted from corporations being able to shelter more income from taxation
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through credits, exemptions, and deductions. Because of the 1981 tax reform,
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corporate income tax collections made up only 6.2% of federal tax revenues
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in 1983, in large part because the 1981 tax act allowed more favorable
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treatment of depreciation. The Tax Reform Act of 1986 contained measures to
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increase the contribution of corporate income taxes to total federal taxes,
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and by 1989 corporate income tax collections made up more than 11% of federal
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tax revenue.
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Taxable income for corporations is computed by subtracting allowable
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expenses from income, but from 1960 to the mid-1980s a greater range of
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expenses was being allowed. An investment tax credit allowed the reduction
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of tax payments by 10% of investment expenditures, and firms were permitted
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to write off large depreciation expenses to lower their taxes. The Tax
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Reform Act of 1986 reduced corporate income tax rates, but corporations must
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pay taxes on more of their income, since less can be deducted. As a result,
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corporate income tax collections as a share of total federal taxes have
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increased by more than 80 percent.
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One controversy regarding corporate tax rates is who actually ends up
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paying the tax. Corporations may raise their prices to cover the corporate
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income taxes they pay, which would mean that the tax is actually paid by the
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corporation's customers rather than by the corporation itself. If the
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corporation did not raise its prices to cover the tax, then the tax would
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lower corporate profits, so that the stockholders of the corporation would
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end up paying the tax. Since insurance companies and pension plans own large
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blocks of stock, the corporate income tax may fall heavily on those
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industries and their customers. Economists agree that the tax is ultimately
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paid from all of these groups, but there is no agreement on who pays how
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much.
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Another controversy regarding the corporate income tax is the issue of
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double taxation. A tax on corporate income taxes the stockholder several
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times because corporations pay income tax on the money they pay out as
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dividends and then the recipient of the dividend must pay personal income tax
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on the dividend. Furthermore, stock is bought with after-tax income, then,
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when the stockholder is paid a dividend from the corporation or sells the
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stock at a profit, the income earned is taxed again. Some people argue that
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corporate income should not be taxed in order to avoid double taxation, while
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others argue that those who earn corporate income can best afford to pay
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taxes. The question is closely related to the issue of who ultimately pays
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the corporate income tax, since corporations really only collect taxes that
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are paid by individual stockholders and customers.
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TAX POLICY AND TAX REFORM
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Originally, the income tax was seen solely as a method of raising revenue,
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but since World War II it has been used as a tool for furthering other goals
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as well. In 1964 a tax cut designed by Presidents Kennedy and Johnson was
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enacted to help the sagging economy. The logic was that a tax cut would give
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consumers more money to spend, which would stimulate business activity. This
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was the first time that income tax reform was undertaken primarily to try to
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fine-tune the economy. </p>
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<p> President Kennedy also instituted the investment tax credit to encourage
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investment, and throughout the 1960s and 1970s many other tax benefits were
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added to the tax system. Among them were oil depletion allowances that made
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oil exploration more profitable, an energy tax credit that provided an
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incentive for energy-efficient investment, and tax exemptions under certain
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conditions for retirement savings and health insurance. Each change, taken
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by itself, had an individual rationale, but the cumulative effect of such
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reforms was to reduce the amount of income subject to taxation, which
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required higher average rates to raise the same amount of revenue.
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Throughout the 1960s and 1970s inflation had the effect of continually
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pushing taxpayers into higher income tax brackets, which provided additional
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revenue to compensate for the increase in tax benefits. Inflation provided
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enough additional revenue that rate reductions to partially offset the
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effects of inflation were also common. The 1981 tax reform act contained a
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provision to automatically index tax brackets to offset inflation, making
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this type of tax reform unnecessary.
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The Tax Reform Act of 1986 was the most comprehensive change in the
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structure of the U.S. income tax since it was enacted. The cumulative effect
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of many small tax reforms over the preceding several decades was to increase
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the number of deductions, credits, and exemptions, which resulted in less
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income being subject to taxation. The 1986 reform was designed to lower tax
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rates while collecting about the same amount of revenue, by eliminating most
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tax preferences and thus increasing the amount of income that could be taxed.
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Reduced tax rates also have the advantages of increasing the incentive to
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earn income, while lowering the incentive for taxpayers to look for tax
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shelters to avoid taxation. One measure of the success of the 1986 tax
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reform is that only minor changes were made to the income tax structure in
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the five years following that reform.
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Randall G. Holcombe </p>
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<p> Bibliography: Bradford, D. F., Untangling the Income Tax (1986); Davies,
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David G., United States Taxes and Tax Policy (1986); Hall, Robert E., and
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Rabushka, Alvin, The Flat Tax (1985); Holcombe, Randall G., Public Sector
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Economics (1988); Peacock, Alan, and Forte, Frances, eds., The Political
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Economy of Taxation (1981); (1985); Strassels, Paul N., The 1986 Tax Reform
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Act (1987). </p>
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<p>TITLE(s): Treasury, U.S. Department of the
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The U.S.
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Department of the Treasury is the department of the executive branch of
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government that oversees the nation's finances. The department was created
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in 1789, and its first secretary was Alexander Hamilton. The secretary of the
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treasury is the second-ranking officer (after the secretary of state) in the
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president's cabinet. The secretary is the president's chief advisor on
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fiscal affairs and is responsible for managing the public debt. The law
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requires the secretary to report each year to the Congress on the
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government's fiscal operations and its financial condition. The secretary is
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also involved in financial dealings with other nations. The secretary has
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special staffs dealing with such matters as defense lending, debt analysis,
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financial analysis, international finance, international tax affairs, and
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law-enforcement coordination.
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The Treasury Department's operating bureaus include the COMPTROLLER OF THE
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CURRENCY, who supervises national banks; the United States Customs Service,
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which collects taxes on goods brought into the country from abroad; the
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Bureau of Engraving and Printing, which produces currency, bonds, Federal
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Reserve notes, and postage stamps; the Bureau of Government Financial
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Operations, which is responsible for the government's cash management
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program and central accounting and reporting system; the Bureau of the Public
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Debt; the INTERNAL REVENUE SERVICE, which collects taxes; the United States
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Mint, which manufactures coinage; the Bureau of Alcohol, Tobacco and
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Firearms, which enforces federal laws on production, use and distribution;
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and the SECRET SERVICE, which protects top U.S. officials and presidential
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candidates and enforces laws against counterfeiting. </p>
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<p> Bibliography: Adams, S., The United States Treasury System (1979);
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Gaines, Tilford C., Techniques of Treasury Debt Management (1962); Gurney,
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Gene and Clare, The United States Treasury: A Pictorial History (1977);
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Taus, Esther R., Central Banking Functions of the United States Treasury,
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1789-1941 (1943; repr. 1966); Walston, M., The Department of the Treasury
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(1989). </p>
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<p>TITLE(s): Internal Revenue Service
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The U.S. government's tax collecting agency, the Internal Revenue Service,
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was created in 1862.
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However, it did not assume its present shape until the federal power to
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tax incomes was sanctioned by the 16TH AMENDMENT (1913) and revenues
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increased enormously after World War II. The IRS, a division of the
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Department of the Treasury, administers all of the internal revenue laws
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except those relating to alcohol, tobacco, firearms, and explosives; its
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most important assignments are to collect personal and corporate INCOME
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TAXES, SOCIAL SECURITY taxes, and excise, estate, and gift taxes.
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The IRS seeks to obtain voluntary compliance with the tax laws as far as
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possible. To this end it stresses communication with taxpayers by providing
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assistance and information for those who need it. Most of the approximately
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118000 employees of the IRS work in field offices throughout the country.
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There are 7 regions, each headed by a regional commissioner, and 64 districts
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administered by district directors. Tax returns are processed in separate
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tax service centers. The national office in Washington, D.C., develops
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policies and supervises the field organization.
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By the early 1980s the IRS was confronting increasing tax evasion and
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taxpayer resistance, fueled by perceptions that the tax laws were unfair and
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administered unfairly. The IRS must interpret the tax laws through the
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regulations it issues, although the IRS is not responsible for writing the
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laws themselves. Despite a massive overhaul of the tax system in 1986, the
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IRS's interpretations are regularly challenged in cases brought to the U.S.
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TAX COURT; and, in adjudication, IRS tax assessments are sometimes rejected.
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It is, however, often possible for businesses and individuals to negotiate
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settlements directly with the IRS.
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Another source of taxpayer unhappiness is the complexity of many of the
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tax forms. They are often so cumbersome and difficult to understand that
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ordinary taxpayers may require the services of an accountant merely to file a
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tax return.
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In its efforts to discover tax evaders, the IRS has invested in
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computerized systems that allow it to gather information from many different
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sources and match it with data in its own files, in order to root out, for
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example, individuals whose life-styles indicate larger incomes than their tax
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returns list. Thus, the IRS can collect information from the 50 states on
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automobile and boat registration, professional licenses issued, and business
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activities that require state permits. It has also attempted to buy
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computerized lists from private marketing organizations. Such activities
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have raised questions relating to the issue of invasion of privacy.
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IRS information has been used by other state and government agencies. In
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most cases--the enforcement of child-support laws, for example, or the
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attempt to find those who have defaulted on student loans--the disclosure of
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information has been authorized by Congress. </p>
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<p> Bibliography: Burnham, David: A Law unto Itself: Power, Politics, and the
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IRS (1990); Saltzman, Michael, IRS Practice and Procedures (1981);
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Shafiroff, I., Internal Revenue Service Practice and Procedure Deskbook, 2d
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ed. (1989). </p>
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<p>TITLE(s): Tax Court, U.S.
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The United States Tax Court is a court of the federal government that
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hears cases brought by taxpayers who challenge decisions of the Internal
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Revenue Service (IRS) dealing with overpayment or underpayment of taxes.
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In many instances the decisions of the U.S. Tax Court can be appealed to
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the U.S. Court of Appeals and ultimately to the Supreme Court. When
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taxpayers exercise an option to agree to the use of simplified court
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procedures in disputes involving $10000 or less, however, the cases tried
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under these procedures cannot be appealed to a higher court. The U.S. Tax
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Court also decides disputes over the rights of taxpayers to see documents and
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other materials that are related to their cases and that are contained in
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IRS files.
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The court is composed of 19 judges appointed for life and 17 special trial
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judges appointed by the chief judge who serve at the pleasure of the court.
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It is augmented by retired judges when the case load is heavy. The court's
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offices are in Washington, D.C., but it maintains a field office in Los
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Angeles and holds trial sessions throughout the United States. </p>
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<p> Bibliography: Taylor, M. W., and Simonson, K. J., Tax Court Practice, 7th
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ed. (1990). </p>
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</xml>
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