29 April 2008
U.S. Government Uses Tax Policy to Shape Economy
Tax system grows more complicated as tool is used more often
This is the third article in a series on the U.S. financial system and market regulation.
Washington -- Americans fought for their independence from the British, in part, because of taxes. "Taxation without representation is tyranny!" was the Colonists' cry. But throughout American history, in good economic times and bad, the question of who pays taxes and how much they pay has been debated vigorously.
EXCISE TAXES AND WHISKEY
The issue of taxes figured prominently not only in the American War of Independence, but in the formation of a federal government. Under the first Articles of Confederation, the government relied on voluntary donations from the states. Only with the ratification of the U.S. Constitution in 1787 did the federal government gain the power to impose taxes.
The new government collected revenue from customs duties and selective taxes -- termed excise taxes -- on such items as liquor, tobacco, sugar and certain legal documents.
Almost immediately, the tax on liquor triggered the "Whiskey Rebellion" in frontier Pennsylvania, which was suppressed by Army troops and established the precedent of the federal government's ability to enforce its tax code.
Excise taxes and duties on imported goods remained the principal source of funding for the federal government throughout the 19th century.
INCOME AND PAYROLL TAXES
The United States briefly imposed an income tax to finance the Civil War; the tax was allowed to lapse in 1872. Only in 1913 did passage of the 16th Amendment to the Constitution empower the government to collect income taxes directly from individuals and businesses.
The income tax fundamentally altered the relationship between individuals and government. Before enactment, according to the Treasury Department, "Most citizens were able to pursue their private economic affairs without the direct knowledge of the government. ... The income tax [gave] government the right and the need to know all manner of an individual's or businesses' economic life."
Out of concern over privacy issues, Congress established the principle that all taxpayer information is confidential.
Income tax rates grew rapidly, especially during World War II, when federal taxes as a share of the gross domestic product (GDP) -- a key measure of the nation's overall tax burden -- jumped from 7.6 percent in 1941 to 20.4 percent in 1945.
The majority of Americans also began paying income taxes through regular withholding from their salaries throughout the year. (See "Americans 'Celebrate' Tax Day.")
The government instituted a payroll tax on employers to fund a public pension fund called Social Security, the nation's first and largest entitlement program, created in 1935. An entitlement program is a program that guarantees a certain level of benefits to persons or entities who meet requirements -- such as age or income -- set by law. (See "Demographic Shifts Demand Fix to Social Security, Official Says.")
Payroll taxes have grown over the years through periodic increases in Social Security taxes and most dramatically in 1965 with the establishment of Medicare, a federal program that covers health care for individuals age 65 and over and those with certain disabilities.
INCREASING COMPLEXITY OF THE TAX SYSTEM
Over the years, the U.S. tax system also has grown complex. The tax code has around 6,000 pages; many Americans use professional tax preparers to file their taxes. One reason for this complexity is that even though the main purpose of taxes is to fund government, tax and spending policy can be a powerful tool for shaping the nation's economy and social welfare. For example, the federal government has used different tax benefits and credits to encourage home ownership and saving for retirement.
The sheer complexity of the U.S. tax system, which has vexed some policymakers and regular taxpayers for years, has prompted frequent calls for tax reform. So far, however, all such efforts have fizzled due to the lack of broad support.
Americans are not taxed heavily, compared to other nations. In 2004, according to the Tax Policy Center, the overall tax burden in the United States was 26 percent of gross domestic product, compared to an average of 36 percent for the member countries of the Organization for Economic Cooperation and Development, which includes most of the world's democratic, market economies.
U.S. corporations complain that the averages hide the fact that relatively high U.S. corporate tax rates put U.S. businesses at a disadvantage vis-à-vis some of their main foreign competitors. Congress has been working on legislation that would reduce U.S. corporate tax rates and discourage companies from seeking escape from their tax obligations in international tax havens or from using complicated, sometimes illegal tax schemes to evade U.S. taxes.
The government occasionally resorts to cutting taxes when hard times come. Beginning in the 1980s, the federal government has instituted several rounds of cuts in both individual and corporate taxes, often creating controversies over who benefits most from such cuts. The Bush administration, for example, cut taxes twice, in 2001 and 2003, citing the need to stimulate the economy and encourage job growth.
See also "U.S. Central Bank Benefits Self-Regulating Economy" and "U.S. Central Bank Works to Smooth Business Cycle."
The U.S. Treasury Department Web site provides a comprehensive set of tax fact sheets, including History of the U.S. Tax System, Economics of Taxation, State and Local Taxes, Questions-and-Answers About U.S. Taxes.
The Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution, also has information on the U.S. tax system.
