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Governments need money so they can provide important services to their citizens. Such services can include national defense from foreign threats, police and fire departments, public schools and libraries, health and sanitation systems, roads, and many others. Governments at all levels, including city, state, and federal, charge citizens and businesses for these services through taxes. The raising of funds through taxes is called taxation. Taxes have been raised as long as governments have existed.

In primitive societies, community members supported common services largely through voluntary labor, to build roads and other facilities. In early European history, payment of tribute (forced payments) to leaders, such as feudal lords, for protection was common. With increasing private ownership of property and businesses, taxation was introduced. Taxes assessed by early European monarchies were often harshly, and unequally, imposed. Taxation was a key point of dispute between the United States and Great Britain leading to the American Revolutionary War (1776–1783). Colonists claimed they were being taxed without having any say regarding the taxes forced on them by the mother country. "Taxation Without Representation" began a popular slogan at the time.

Following independence from Great Britain, the nation's Founding Fathers addressed taxation in Article 1 of the U.S. Constitution. Adopted in 1786, the Constitution included the Tax and Spending Clause giving Congress power to "lay and collect Taxes, Duties, Imposts [duties on imported foreign goods], and Excises [taxes on domestic goods], to pay the Debts and provide for the common Defence and general Welfare of the United States." The rise of democratic societies, such as in the United States, required that taxation be more fairly applied in order for taxpayers to cooperate. The growth of trade and commerce led to a more complex taxation system. The change of the U.S. economy in the nineteenth century from agrarian (based on agriculture and farms) to industrial (factories) brought yet new kinds of taxes, and even more complexity including greater difficulty in record keeping and tax collection. Recognizing the importance of taxation to the well-being of the nation, the Court has traditionally interpreted Congress' taxing powers very broadly. Not only does the Tax and Spending Clause give Congress taxation powers, but other parts of the Constitution does also including the Commerce Clause as recognized in the Head Money Cases (1884) ruling. The Commerce Clause gives Congress power to regulate trade between states and with foreign nations and Indian tribes.

Taxation can take many forms. The federal government relies on import (tariffs), excise taxes, personal income and corporate (business) taxes, and Social Security taxes in addition to other revenues. State governments rely primarily on personal and corporate income taxes, sales taxes, and certain fees, such as hunting and fishing licenses. The property tax is primarily used by local governments. Other taxes include estate, inheritance, and gift taxes.

Federal Government Tariffs

Prior to the American Civil War (1861–1865) funding support for the U.S. government came primarily from tariffs. Tariffs are taxes placed on goods that one nation imports from another. Tariffs date back at least to the 1200s when the European Christian Crusades brought increased trade between Europe and the Middle East. Early tariff agreements were struck between Italian merchants and commercial partners in Asia and Africa. With the discovery in 1492 of New World populations and resources by European powers, foreign trade greatly increased. High tariffs were put in place by European countries.

High tariffs charged by Great Britain on goods exported from the colonies was a major factor leading American colonists to rebel against British domination. Shortly after gaining independence in the American Revolutionary War (1776–1783), Congress passed the Tariff Act of 1783. Tariffs were established to protect the newly emerging American industries and to raise revenue for the government, impoverished from the war effort.

The industrialization period of the nineteenth century led to increased production of goods, particularly in the North. The nation became split over tariff policies. Northern states wanted to raise prices of foreign goods through higher tariff rates to promote sales of their own goods. Southern states sought low tariffs since they still imported much of their goods from Britain. The tariff dispute was one factor besides slavery that led to the American Civil War (1861–1865).

Besides raising revenue for the federal government, tariffs also serve to protect U.S. industries from foreign competition. The tariff taxes increases the price of foreign goods, making U.S. made goods more attractive to buyers. By selling more goods, the tariffs encourage increased production by U.S. firms. The U.S. Constitution prohibits tariffs on exports from the United States to other nations.

Tariffs also can serve political purposes, such as protesting the policies of another nation by increasing the prices of their goods into the country. For example, in the 1990s the United States placed high tariffs on Japanese produced goods because of Japan placing strict limits on the amount of U.S. goods going into their country.

International agreements are often signed between nations setting low tariffs, or maybe even no tariffs at all, on each others goods. The United States maintains special tariff agreements with countries it extends most-favored-nation (MFN) status to. Low, preferential, tariffs may also be applied to underdeveloped nations to assist in their economic development.

In addition to tariffs charged on foreign goods sold in the United States, U.S. citizens also may have to pay duties to the U.S. Customs Service for certain goods purchased.

Excise Taxes

Whereas tariffs deal with foreign made goods, taxes placed on the purchase of domestic goods, goods made within the United States, are called excise taxes. Such taxed items include alcohol, firearms, tobacco, gasoline, and diesel fuel. In 2000, the federal tax on gasoline was 18.4 cents per gallon, on truck diesel fuel 24 cents a gallon. States also add taxes that vary from state to state. Revenues from taxes on gasoline and diesel fuel sales are specially directed to road construction projects. For a long time the United States also had a luxury tax applied to such items such as automobiles. However, the tax has been steadily phased out and will end altogether in 2002.

Income Tax

The most commonly known form of tax in modern America is the tax on incomes, both on individuals and corporations. Taxable income can include wages and salaries, rent, interest earned, and corporate earnings.

The personal income tax was first used in the United States during the American Civil War to pay for war expenses. Passed by Congress in 1862, the tax was repealed (canceled) a few years later. In 1894 Congress brought back the income tax on individuals and companies, assessing 2 percent of income. However, the following year the U.S. Supreme Court declared the tax unconstitutional. The Court ruled in Pollock v. Farmer's Loan and Trust Company (1895) that such a tax would be violating Article I since the revenue gained was not be distributed to services in the states in direct proportion to each state's population as directed by the Article.

Consequently, no national income tax existed until adoption of the Sixteenth Amendment in 1913. The amendment gave Congress authority to levy (collect) taxes on any form of income without the requirement of distributing the funds among the states in proportion to their populations. With its new power, Congress passed the Tariff Act of 1913 creating a tax system for individual and corporate incomes.

Individual, or personal, income taxes are a form of "progressive taxes." The higher a person's income, the higher the percentage of his income is collected for taxes. Therefore, people with higher incomes and a greater ability to pay provide most of the income tax revenue. By the late twentieth century, those with lower incomes paid 15 percent of their income in taxes, the highest incomes paid 40 percent. Corporate income taxes were based on profits and not as progressive as the personal income tax structure.

Social Security and Medicare

In 1935 Congress passed the landmark Social Security Act. The act provides old-age benefits and health insurance, known as Medicare, for people over sixty-five years of age. To fund these government programs, a payroll tax was created. Employers are responsible for paying these taxes instead of the workers. Money is deducted (withheld, subtracted) from an employee's wages before she receives her paycheck. The employers then must equally match that amount of funding from their own funds. The employers pay these taxes directly to the U.S. Treasury. People self-employed (working for themselves) have to pay income, Social Security, and Medicare taxes from their earnings. The tax and spending powers of Congress to withhold money from people's paychecks for retirement benefits was immediately challenged in 1937 after the Social Security Act was passed. The powers were affirmed by the U.S. Supreme Court in Helving v. Davis (1937).

State and Local Taxes

State and local governments are given authority through the Tenth Amendment to raise revenue in a variety of ways. Under the Tenth Amendment, states can claim powers not specifically reserved for the federal government nor denied to the states. Like the federal government, most states also have income taxes. These taxes are charged at a lower rate than the federal government.

Many state and local governments largely rely on sales taxes. Most goods and services purchased are assessed a certain tax level. Because of the sales tax effect on the poorer citizens, some goods considered essentials, such as food, clothing, and medicine, are exempt from the sales tax or are taxed at a lower rate. Property taxes are also a key means of raising revenue. Land and buildings, such as homes, are taxed a certain percentage based on their assessed (estimated) value. Many local governments rely heavily on property taxes to fund public schools.

Corporations and manufacturers are also assessed business taxes by states and local governments. In addition, various stages of production and distribution of goods can be taxed. These taxes add to the value of the final product and increases the costs paid by the purchasers. Also, companies can be assessed franchise taxes, the cost on the privilege of doing business in the state. Companies must also pay taxes to operate state unemployment compensation programs, government insurance established by the Social Security Act of 1935 for those who lose their jobs through no fault of their own. The unemployed receive a certain amount of money weekly for a limited period of time.

State and local governments will also charge set fees to professionals for obtaining a license to practice their profession.

Estate, Inheritance, and Gift Taxes

The federal and state governments also assess different kinds of taxes on money and property passing from deceased persons to their heirs. An estate tax is charged for the privilege of transferring property from people who have died to their heirs. It is assessed on the entire estate before it is distributed. The inheritance tax is paid by each heir for the privilege of receiving property from a deceased. A person pays a gift tax if they decide to give a valuable gift to another person.

Collecting Taxes

The Internal Revenue Codes include federal laws directing how the various types of taxes are paid, whether income, business, or estate. The Internal Revenue Service (IRS), first created in 1862, is part of the U.S. Department of Treasury and responsible for collecting federal taxes. It is called Internal Revenue because it collects tax money from sources within the United States. Perceived abuses of the IRS in collecting taxes led to passage of the Taxpayer Bill of Rights in 1988 which was expanded in 1996. Many states passed similar state laws regarding collection of state taxes. The Taxpayer Bill of Rights gives taxpayers greater ability to question IRS findings and to be represented by lawyers or accountants.

Tax Disputes

Considerable debate surrounds the tax systems found in the United States. Fundamental concerns about taxation focus on equality and fairness. The burden of taxation must be imposed as equally as possible on all classes of people. This requirement led to progressive rate income tax systems. Higher rates are charged to people with higher incomes. However, the idea of equality of taxation does not mean that all the people must equally to enjoy the benefits of governments services. For example, couples who do not have schoolchildren still must pay taxes to support local schools.

The U.S. federal tax laws had become incredibly complex by the late twentieth century. The amount of time spent by individuals and corporations to compute and pay taxes was estimated to cost billions of dollars each year. Those supporting tax reform charge that the complexity leads to higher rates of tax avoidance with wealthy individuals and companies taking advantage of numerous legal opportunities to lessen their taxes paid. This is considered unfair to those in the middle and lower income levels with less opportunity to decrease their tax burden. Some want to shift a greater tax burden onto corporations, but others argue that these taxes would generally be passed on to individuals through higher prices for goods and services.

Also, many argue that the income tax which includes a tax on interest gained from savings accounts substantially discourages saving. The United States has the lowest saving rate among the western industrial countries. This situation forces corporations to seek loans outside the country. Many also claim that property taxes discourages home ownership. Reliance on property taxes also means wealthier communities have better schools and better government services.

A major push for tax reform forced consideration of alternative means of taxing. One alternative was the flat-rate tax system which would greatly simply the process. All citizens would pay taxes at a set rate and corporations would pay at a lower rate. However, opponents to the flat-tax claimed this alternative would potentially shift a larger tax burden onto the lower income population. Another alternative would be replacing the federal income tax with a national sales tax. This system could encourage saving but again place a greater burden on lower income citizens.

Tax Court System

Article I of the Constitution also gave Congress authority to establish a tax court system. The U.S. Tax Court was originally established by the Revenue Act of 1924. State and federal tax courts deal solely with tax disputes. Such disputes typically involve arguments over the assessment of property values or tax status of certain organizations. Decisions of the tax courts may be appealed to the U.S. courts of appeals and the U.S. Supreme Court.

Tax evasion is a criminal offense under federal and state laws. Prison sentences and fines may be imposed on those convicted. In order to gain criminal conviction, a deliberate attempt to illegally avoid paying taxes must be proven as ruled by the Supreme Court in Spies v. United States (1943). The decision in Sansone v. United States (1969) set further standards for proving criminal conduct.