Federalism & the Tax System………………………………………
Federal Taxes and Intergovernmental Revenues. Tax Reform……
The Progressivity of the Tax System. Political Influences on the Tax System………………………………….……………………………..12
The purpose of our research - to characterize US tax system. First we shall tell about main principles of US tax system. In chapter 1 we cover principles of federalism in tax system.
In chapter 2 we shall discuss the basic federal taxes and intergovernmental revenues. Also chapter 2 covers main US tax reforms and their influences on a tax policy as a whole. After examining some basic facts about the tax system, the remainder of tile chapter turns to matters dealing with tax policy.
One issue that has surfaced with regard to individuals taxes is the degree of progressivity of particular taxes, but a more relevant consideration is the degree of progressive of the tax system as a whole. It is a subject of chapter 3. If some taxes are regressive while others are progressive, their effects can offset one another, and a very regressive tax might be acceptable, or even desirable, within the context of the entire, tax system. After all we shall tell about political influences on the tax system.
Federalism & the Tax System
Let's tell some words about a tax policy all over again. One important aspect of tax policy is that the optimal provisions for one type of tax will often depend on the way in which other taxes are levied. A tax should be efficient and equitable when analyzed on its own, but often the efficiency and equity of a tax depend upon how it fits in with the whole system of taxes. So, taxes must be viewed as individual components of an overall tax system to really understand their effects.
The United States has a federal system of government, and, followings that model, the tax system can be divided into the three major categories of federal, state, and local taxes. Federal, taxes make up about 56 percent of total taxes, although federal expenditures are: only about half of total expenditures. The difference occurs because a substantial fraction of state and local government expenditures are, financed by federal government grants. Intergovernmental grants make up nearly one-third of local government revenues. One of the goals of this chapter is to examine how the various levels of government raise revenues to finance their expenditures.
The federal government collects more in revenues than all other governments in the United States combined. Table 1 lists the percentage breakdown of all government own-source revenues and own-source revenues from major tax bases. Own-source revenues excludes intergovernmental grants, which are discussed in a separate section later, but includes revenues collected from fees and user charges, which might ordinarily not be considered as tax revenue. As table 1 shows, the federal Government collects 56.4 percent of total government revenues, with states collecting 24.3 percent and local 19.3 percent. [1, p.305]
Although all levels of government tend to collect revenues from a variety of sources, more taxes than all table 1 shows that the different levels of government rely on different tax bases to state and local different degrees. Most income taxes are collected by the federal government, which collects 81 percent of all individual income taxes and 81.5 percent of all corporate income taxes. States collect about 17 percent of both individual and corporate income tax payments, and local governments collect less than 2 percent. Thus, while states rely to a significant degree on income tax collections, the income tax is primarily a federal tax. When considering the income tax from an equity standpoint, this is even more true because most states base their income tax structures on the federal income tax structure, so changes in federal tax laws can have a significant effect on state income tax collections, both in terms of the amount of tax collected and in terms of the distribution of income tax payments among taxpayers.
The tax that is most clearly assigned to one level of Government is the property tax. More than 96 percent of property taxes are collected by local governments. Sales and gross receipts taxes, taxes are collected primarily by state governments. Although 62.9 percent of sales and gross receipts taxes are collected by states, both the federal government and local governments collect a significant amount. The federal government collects 24 local governments 24 percent of sales and gross receipts taxes, mostly through federal excise taxes on motor fuel, alcohol, and tobacco. [1, p.307] Local governments collect 13. 1 percent of sates and gross receipts taxes, coming from a combination of local general sales taxes, excise taxes on gasoline, and other less significant excise taxes.
Stepping back to examine the overall tax system, we see that the federal government relies primarily on income taxes, state governments on sales taxes, and local governments on property taxes. This division makes some sense when one considers the mobility of tax bases.
Although the property tax has remained a local tax, the income tax is becoming, increasingly important at the state level, as will be discussed later, so states might be viewed as encroaching on a traditionally federal tax base. Likewise, the federal government collects a significant amount of sales and gross receipts taxes, primarily as excise taxes, which might be viewed as taxing a state tax base. One factor relevant to the discussion of a federal value added tax is that, as a consumption tax, it would be placed on a tax base that has traditionally been used by state governments. This was less of an issue when the value added tax was adopted by European governments because tax systems in Europe tend to be more centralized than the tax system in the United States.
So, we can divide US tax system into the three major categories of federal, state, and local taxes. Intergovernmental grants make up nearly one-third of local government revenues. The federal government collects more in revenues than all other governments in the United States combined.
Most income taxes are collected by the federal government, which collects 81 percent of all individual income taxes and 81.5 percent of all corporate income taxes. Thus, while states rely to a significant degree on income tax collections, the income tax is primarily a federal tax.
We see that the federal government relies primarily on income taxes, state governments on sales taxes, and local governments on property taxes. This division makes some sense when one considers the mobility of tax bases.
Federal Taxes and Intergovernmental Revenues. Tax Reform
The federal government relies on income and payroll taxes for the vast majority of its revenues. Table 2 shows the percentage breakdown for four categories of federal tax revenues and shows that the personal income tax is by far the most significant source of federal government revenue. Social insurance payroll taxes, which consist mostly of Social Security and Medicare taxes, make up the second-largest category, and this category is the only one that increased its percentage contribution from 1990 to 1999. Both corporate income taxes and excise taxes have fallen slightly in importance over that period.
The increased importance of Social Security taxes is worth considering from an equity standpoint. Although the income tax structure is designed to be progressive, the Social Security tax structure is regressive because it taxes income at a flat rate up to t maximum amount and is not collected on income above the maximum. [2, p.122]
When Social Security taxes were relatively low, the regressive nature of the tax might not have been much of an issue, but with rising Social Security tax rates and uncertain future benefits, the issue is worth considering. The progressivity of the tax system is reduced when social insurance taxes replace income taxes. Although the expected future benefits are a relevant and offsetting factor, normally the progressivity of the tax structure is analyzed independently of the distribution of tax benefits.
One of the important points to note from the numbers in table 2 is that income and payroll taxes make up about 90 percent of federal government revenues. The bulk of those taxes are levied on individuals in the form of the individual income tax and social insurance taxes. [1, p.320]
One of the major sources of revenues for lower-level governments is intergovernmental revenue. Revenues collected by the federal government are distributed through grants to state and local governments, and state governments also provide financial assistance to local governments. Intergovernmental revenues make up about 22 percent of total state government revenues and 33 percent of local government revenues. [1, p.320] There is some double counting here because the federal government can provide revenues to states, who then distribute revenues to localities. Also, local governments sometimes borrow from state governments and repay loans, so intergovernmental revenues to state governments can come from both federal and local governments. However, the most significant intergovernmental revenues consist of federal aid to state and local governments.
As a percent of state and local government spending, federal aid peaked in the late 1980s at about 24 percent of state and local government expenditures and has since declined to about 17 percent. Although they have been declining slowly in importance, intergovernmental revenues are still large and can have significant effects on government finance.
Although each individual intergovernmental transfer program will have its own motivation, there are three basic reasons why intergovernmental transfer programs might be established: (1) higher-level governments provide money to encourage certain types of programs by lower-level governments; (2) taxation for lower-level governments can be shifted to higher-level governments, where taxes are harder to avoid; and (3) programs are established for equity reasons, to give poorer states or localities parity with richer states or localities in funding government programs. [2, p.158]
But state governments rely mainly on sales and income taxes for their revenues, while local governments rely mainly on property taxes.
Now we shall tell about tax reforms. Tax laws are continually being modified at all levels of government. Indeed, most changes in tax law tend to be small changes that directly affect only a few taxpayers, and with good reason. Changes in any laws tend to be initiated as a result of a demand for the change, and special interests will consistently demand changes that will benefit them, while the general public will remain on the sidelines of most policy debates. Thus, the tax laws change as one small provision after another is added to the tax code as a result of requests from special interests.
Although each change by itself may have a plausible rationale, changes in the tax code tend to be in the form of loopholes that allow some taxpayers to reduce their tax payments. This was the general idea that drove the federal income tax reform in 1996. The tax code had so many loopholes in it that much income was escaping taxation, making everyone’s tax rates higher. If all the loopholes and special interest benefits could be done away with, everyone could have lower tax rates but the tax system could still raise the same amount of revenue.
Thus, the idea of that tax reform was to broaden the tax base by closing loopholes and making more income subject to taxation and lowering rates to raise the same amount of revenue. That effort at reform was mostly successful for two reasons. It considered the tax system as a whole rather than piecemeal, and the reform proposals were revenue neutral, which meant that they all proposed a more efficient tax structure that would raise the same amount of revenue. [1, p.356]
When tax reform takes place by examining one small tax issue after another, special interests can have undue influence over the reform process, and the resulting reform will tend to favor special interests rather than the general public interest. Small changes to the tax code will not affect most people very much one way or the other, so it will not pay them to get involved in the debate, whereas special interests can benefit substantially from small changes in the tax code. Thus, when the tax code is changed a little at a time, special interests will tend to benefit, and the tax code will become increasingly complex as loopholes are added to the tax system one at a time.
This problem of an overly complex tax code ridden with loopholes may be overcome by proposing a complete overhaul of the tax system that does away with all the loopholes in exchange for lower tax rates for everyone. Everyone tends to lose some special interest benefits with such a reform, but, overall, the more efficient tax code with lower rates can more than make up for the loss of these special interest benefits. Thus, a comprehensive tax reform has the potential to be a Pareto superior move, and all citizens can agree to give up their loopholes in exchange for a more efficient tax system that improves the welfare of all. This was the philosophy underlying federal tax reform in 1996.
Since the 1996 tax reform, changes in the tax code have been small ones, and this type of change is likely to benefit special interests rather than further the general public interest. Cynics might even suggest that by 1996, Congress had created just about all the special interest loopholes that it could fit into the tax code and that to create any more would have required taking away someone else’s. Therefore, Congress moved to eliminate as many of the special interest provisions as it could so that it could start giving them out again, one at a time, in exchange for renewed political support from the favored special interests. An optimist can hope that once a better tax system has been enacted, Congress and the general public will resist tampering and might even improve upon it.
For special interests in the private sector, the tax code provides a method by which they might be able to produce benefits for themselves. For governments, the tax system is a method of raising revenues. With the federal government running a substantial deficit and states and localities also finding themselves strapped for revenues, many people see tax reform as an opportunity to generate more revenues for cash-strapped governments. This view is not universal, however, and others think that governments spend too much and that taxes should be cut. Inevitably, when tax matters enter the political debate, there will be tension between those who think the government needs to increase taxes and those who think taxes need to be cut.
Both groups should agree that however much revenue the government raises, it should do so as efficiently as possible. Thus, there is a possibility to get agreement among all parties to create a more efficient tax structure if they can lay aside differences regarding whether the government should increase or decrease its revenues.
Agreeing to adhere to the principle of revenue neutrality when changing the tax structure partitions the policy debate so that issues regarding how much revenue the government should raise can be considered separately from efficiency and equity issues. On one side of the partition, legislators can debate how to create a fair and efficient tax structure, leaving the amount of revenues unchanged, and, on the other side of the partition, they can debate whether tax rates should be raised or lowered to collect the right amount of revenue.
So, the federal government relies on income and payroll taxes for the vast majority of its revenues. Social insurance payroll taxes, which consist mostly of Social Security and Medicare taxes, make up the second-largest category. When Social Security taxes were relatively low, the regressive nature of the tax might not have been much of an issue, but with rising Social Security tax rates and uncertain future benefits, the issue is worth considering.
One of the major sources of revenues for lower-level governments is intergovernmental revenue. Revenues collected by the federal government are distributed through grants to state and local governments, and state governments also provide financial assistance to local governments.
But tax laws are continually being modified at all levels of government. Although each change by itself may have a plausible rationale, changes in the tax code tend to be in the form of loopholes that allow some taxpayers to reduce their tax payments. Thus, the idea of tax reform was to broaden the tax base by closing loopholes and making more income subject to taxation and lowering rates to raise the same amount of revenue.