Taxes and Government Spending - Overview

Governments are responsible for providing services that individuals cannot effectively provide for themselves, such as military defense, fire and police departments, roads, education, social services, and environmental protection. To generate the revenue necessary to provide these services, governments institute taxes based on income, consumption (sales taxes), and wealth (property and estate taxes). Taxes are broadly defined as being either direct or indirect. Direct taxes (for example, the federal income tax) are paid by the person on whom the tax is being levied. Indirect taxes are passed on from the responsible party to someone else. Examples of indirect taxes include business property taxes, gasoline taxes, and sales taxes, which are levied on businesses but passed on to consumers via increased prices.

When individuals with higher incomes pay a higher percentage of a tax, it is considered a "progressive" tax; when those with lower incomes pay a larger percentage of their income, a tax is considered "regressive." The federal income tax is an example of a progressive tax, because individuals with higher incomes are subject to higher tax rates. Sales and excise taxes are regressive, since the same tax applies to all consumers regardless of income, so less prosperous individuals pay a higher percentage of their incomes.

The most common taxes levied by federal, state, and local governments include the following:

• Income taxes—charged on wages, salaries, and tips
• Payroll taxes—social security insurance and unemployment compensation, which are paid by employers and withdrawn from payroll checks
• Property taxes—levied on the value of property owned, usually real estate
• Capital gains taxes—charged on the profit from the sale of an asset such as stock or real estate
• Corporate taxes—levied on the profits of a corporation
• Estate taxes—charged against the assets of a deceased person
• Excise taxes—collected at the time something is sold or when a good is imported
• Wealth taxes—levied on the value of assets rather than on the income they produce

Tax Burden

The amount of tax an individual or family pays to the government, including their income, payroll, excise, and other taxes, is known as their tax burden. According to Isaac Shapiro in "Overall Federal Tax Burden on Most Families—Including Middle-Income Families—at Lowest Levels in More Than Two Decades" (Center on Budget and Policy Priorities, April 10, 2002), the median four-person family with two dependents paid 6.8% of its income in federal income tax in 2001, which was the lowest percentage since 1957.

Natwar M. Gandhi, the chief financial officer of the District of Columbia, estimated in Tax Rates and Tax Burdens: In the District of Columbia—A Nationwide Comparison (August 2004) that an American family of four with an income of $50,000 paid an average of 8.3% of its income in state and local taxes in 2003, including $1,561 in state or local income taxes, $1,843 in property taxes, $797 in sales taxes, and $247 in automobile taxes. At the $75,000 income level, American families paid an average of $6,832 in state and local taxes, or 9.1% of their income in 2003. According to Gandhi, Bridgeport, Connecticut, had the highest taxes of the fifty-one cities in the study. Families at the $50,000 income level living in Bridgeport paid 13% of their income ($7,501) in state and local taxes in 2003. For families in Bridgeport earning $75,000, the state and local tax burden increased to 17.7%, or $13,272.

International Comparisons

Although Americans commonly complain about the amount of taxes they pay, the overall tax burden in the United States is generally lower than it is in other advanced economies. According to the Organisation for Economic Co-operation and Development (www.oecd.org), at the turn of the twenty-first century the tax burden as a percentage of the gross domestic product (GDP; the total value of all goods and services produced by an economy) in the United States was 29.6%, which compared favorably with such nations as the United Kingdom (37.4%), Canada (35.8%), France (45.3%), Germany (37.9%), and Sweden (54.2%), but was higher than Korea (26.1%) and Japan (27.1%). According to "How Competitive Is the U.S. Tax System?," a study issued by the Joint Economic Committee of the U.S. Congress in April 2004, the United States imposed the lowest taxes on the personal income of wealthy individuals during 2003 among eight leading industrial nations and was the only country without a national sales tax. (See Table 8.1.) However, when comparing tax rates in the United States to those in Australia, Canada, France, Germany, Italy, Japan, Spain, and the United Kingdom, the study reported that the U.S. corporate tax rate, which is 35% at its maximum, was among the highest, and the United States was the only country to tax corporate profits at both the corporate and the individual levels—that is, the corporation pays corporate taxes on its profits, and when the profits are distributed to shareholders as dividends, the shareholders also pay taxes on that income.