Taxation (West's Encyclopedia of American Law)
The process whereby charges are imposed on individuals or property by the legislative branch of the federal government and by many state governments to raise funds for public purposes.
The theory that underlies taxation is that charges are imposed to support the government in exchange for the general advantages and protection afforded by the government to the taxpayer and his or her property. The existence of government is a necessity that cannot continue without financial means to pay its expenses; therefore, the government has the right to compel all citizens and property within its limits to share its costs. The state and federal governments both have the power to impose taxes upon their citizens.
Kinds of Taxes
The two basic kinds of taxes are excise taxes and property taxes.
Excise Tax An excise tax is directly imposed by the law-making body of a government on merchandise, products, or certain types of transactions, including carrying on a profession or business, obtaining a license, or transferring property. It is a fixed and absolute charge that does not depend upon the taxpayer's financial status or the value that the taxed property has to the taxpayer.
An estate tax is a tax that is placed on, and paid by, the estate of a decedent prior to the distribution of the...
(The entire section is 1224 words.)
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Taxation (Great American Court Cases)
Although several countries in Europe, including France and Great Britain, had begun a personal income taxation system in the 1700s, the United States did not adopt an income tax until 1862, during the Civil War. A few years later, however, this wartime measure was repealed.
In 1894 Congress tried again by initiating a two percent tax on individual and corporate income. But in 1895 the Supreme Court declared the levy unconstitutional. Article 1 of the U.S. Constitution states that "direct taxes shall be apportioned among the several states." Direct taxes are those which are levied on the property, business, or income of the individual who pays the tax. The Court ruled that the U.S. Constitution prohibited the federal government from enacting an income tax because revenue derived from the tax would not be distributed in direct proportion to the nation's population.
It would take the ratification of the Sixteenth Amendment in February of 1913 to pave the way for creation of a national income tax. The amendment provided Congress with the power to levy "taxes on income, from whatever source derived, without apportionment among the several States." The Tariff Act of 1913 included a provision for a tax on individual and corporate incomes. Before a national income tax was adopted, the U.S. government relied primarily on income generated from...
(The entire section is 1928 words.)
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Taxation (Encyclopedia of Business and Finance)
Taxation is the imposition of a mandatory levy on the citizens and/or the businesses of a country by their government. In almost every country, the government derives a majority of its revenues for financing public services from taxation. Most individuals will feel the impact of quite a number of taxes during their lifetimes. In addition, taxes have become a powerful instrument for policy makers around the world to use in attaining economic and social goals. As a result, the system of taxation in the United States and elsewhere has an impact on almost every business and investment decision that is made.
NATURE AND HISTORY OF U.S. TAXATION
In 1936, the U.S. Supreme Court defined a tax as "an exaction for the support of the Government." In this regard, there is no direct relationship between the exaction of revenue by the government and any benefit to be received by the taxpayer. As a result, a taxpayeruch as a corporate shareholderannot trace his or her tax payment to any particular governmental asset or program. Taxes may be distinguished in a similar fashion from licenses and from fees, which are payments made to the government for some special privilege granted or service rendered (such as a marriage license or a camping fee). They can also be distinguished from regulations and from penalties, which are charges imposed by government to eliminate or control a specific activity.
For taxes to pass constitutional muster, they must be levied on the basis of predetermined criteria. Not only must taxes be determined objectively, but also taxpayers must be able to calculate their tax liability ahead of time. Since most taxes are levied on a recurring or predictable basis, individuals can also engage in tax planning or in tax avoidance. In other words, they are free to conduct their lives in a way that minimizes the amount that must be transferred to the government in taxes.
Despite the adage that nothing is certain in the world but death and taxes, taxation has not always been the chief source of revenue for governments. While the primary goal of taxation is to provide the resources necessary to fund governmental expenditures, any taxing authority that has the power to control the money supplyuch as the U.S. federal governmentan satisfy its revenue needs merely by creating money. Complete reliance on this governmental power, however, would stimulate excess demand in the economy, whichn turnould cause price inflation. Taxes, on the other hand, raise revenue with the opposite effect: They drain money from the private sector, causing a reduction in private consumption or investment expenditures.
Reflecting one of the rallying cries of the American RevolutionNo taxation without representation"he system of taxation in the United States closely parallels the tax regime of England. At the time of its adoption in 1789, the U.S. Constitution gave Congress the power to levy and collect taxes. Promptly exercising this authority, Congress enacted was the Tariff Act of 1789, imposing a system of dutiesalled excise taxesn imports. As a result, tariffs became the federal government's principal source of revenue.
As the scope of governmental activities and programs increased, additional sources of revenue were necessary to supplement the tariff system. However, the Constitution required that any direct tax imposed by Congress had to be apportioned among the states on the basis of their relative populations. Because the sizes of the states' populations differed, any tax on income would result in a different tax rate for the citizens of each state. Despite the apportionment requirement, Congress enacted the first federal income tax in 1861 to finance the vastly increased expenditures brought on by the Civil War.
While the original federal income tax was allowed to expire after the Civil War, it did lead to the successful effort to amend the Constitution. The Sixteenth Amendment to the Constitution became effective on February 25, 1913, providing that: "The Congress shall have the power to lay and collect taxes on incomes from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration." Without hesitation, Congress enacted the Revenue Act of 1913, on October 3, 1913 and made it retroactive to March 1, 1913.
As historical conditions changed and the federal government's need for additional revenues increased, Congress exercised its income taxing authority by the passage of many new revenue acts. Since each new piece of legislation simultaneously reenacted previous revenue acts and added new amendments to the law, it became necessary to research over one hundred separate statutory sources to determine what tax law was currently in effect. Eventually, in 1939, Congress resolved the confusion by systematically arranging all of the tax laws into the Internal Revenue Code of 1939, a permanent codification of the law that does not require reenactment.
MAJOR TYPES OF U.S. TAXES
Since its establishment in 1913, the income tax has played the dominant role in providing the funds with which the federal government operates. An income tax is an extraction of some of the taxpayer's economic gain, usually on a periodic basis. The federal government, and almost every state government, imposes a tax on the income of individuals, corporations, estates, and trusts. A final tax reckoningnvolving the reporting of income and payment of taxes dues made at the end of each year. However, in order to ensure tax collections, Congress has created a pay-as-you-go requirement, through a combination of payroll with holdings and estimated tax prepayments during the year.
Income is generally defined as any permanent increment to wealth. It does not include loans or any other temporary increments. As a general rule, Congress considers any incremental wealth to be taxable income, unless specific statutory authority excludes it. These increments to wealth can take many forms, such as cash, property other than cash, and services that are ren dered to the taxpayer. While state governments set their own tax rules and rates, a majority of the states use the same definition of gross income as the federal government.
Unlike federal and state income taxes, wealth-transfer taxes are not significant revenue producers. Historically, the primary function of wealth-transfer taxes has been to hinder the accumulation of wealth by family units. Since 1976, the federal estate tax and the federal gift tax have been combined into one tax, known as the unified transfer tax. This unified system eliminates the distinction previously made between taxable lifetime transfers and transfers at death. Under this system, the value of a decedent's taxable estate is treated as his or her final gift.
Like federal income taxes, the tax rates on unified transfers are progressive. This means that an increasing percentage rate is applied to increasing increments of the tax base. Unlike the annual assessment of federal income taxes, the federal transfer tax is computed cumulatively on gifts made during a lifetime as well as on transfers at death. In addition, many states impose an inheritance tax on the right to receive property at death. Unlike an estate tax, which is imposed according to the value of property transferred at death, an inheritance tax is imposed on the recipient of property from an estate, although many wills provide that the estate should pay any inheritance taxes imposed on recipients of property.
In addition to income taxes and wealth transfer taxes, the federal government and most states impose some form of employment tax. The most common form of state employment tax is levied on wages, with the proceeds used to finance that state's unemployment compensation benefits program. In addition to its own unemployment tax, the federal government also imposes a Social Security tax on employers, employees, and self-employed individuals. The federal government uses proceeds from the Federal Insurance Contribution Act (FICA) tax to finance the payment of Social Security benefits as well as Medicare health insurance. If an employee will be eligible for Social Security and Medicare, the FICA tax is paid by both the employee and by his or her employer. Although subject to a different tax rate, self-employed individuals are required to pay FICA taxes on their net earnings from self-employment.
With only a few exceptions, state and local units of government in the United States also use the income tax and wealth transfer taxes as a source of revenue. In addition, these taxing jurisdictions have customarily relied on two other tax sources that generally escape taxation by the federal government:
- The annual assessment of property tax has traditionally been the backbone of the local revenue system. It is a tax on the value of propertysually only real property, such as land and buildingsowned within a jurisdiction by nonexempt individuals or organizations.
- In addition, most states and many local units of government impose sales taxes. This is a tax on the gross receipts from the retail sale of tangible personal propertyuch as automobiles and clothingand certain services. Each taxing authority determines its own tax rate as well as the services and articles to be taxed. The seller collects the tax at the time of the sale, and then periodically remits the revenue to the appropriate taxing authority.
In the United States and other democracies, a majority of citizensr their duly elected representativesote to impose taxes on themselves in order to finance public services on which they place value but which are not adequately funded by market processes. However, determining which individuals or households or businesses actually reduce their private consumption or wealth as a consequence of a tax is not always a straightforward matter. After all, although taxes affect numerous aspects of our lives, their impact is not uncontrollable.
Tax planning is simply the process of arranging one's actions in light of their potential tax consequences. After all, a character in Gone with the Wind improves on the earlier adage by ob serving, "Death and taxes and childbirth! There's never any convenient time for any of them!" Despite the inconvenience that taxes impose, the average individual will feel the impact of quite a number of taxes during his or her lifetime. As a result, almost any attempt to accumulate or pre serve wealth requires diligent tax planning.
The process of minimizing the tax liabilityof an individual or of a transactions usually referred to as tax avoidance. Not to be confused with tax evasion, tax avoidance is the perfectly legal effort by taxpayers, and by paid tax advisers on behalf of their clients, to take those steps necessary to reduce one's taxes. As a result, any one interested in minimizing their tax liabilities in the United States should take their cue from a 1947 opinion by Justice Learned Hand: "Over and over again courts have said that there is nothing sinister in so arranging one's affairs so as to keep taxes as low as possible. Everybody does so, rich or poor, and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is pure cant."
Brownlee, W. Elliot. (1996). Federal Taxation in America: A Short History. Washington, DC: Woodrow Wilson Center Press.
Graetz, Michael J. (1997). The Decline (and Fall?) of the Income Tax. New York: Norton.
Jones, Sally M. (1998). Principles of Taxation for Business and Investment Planning. Boston: Irwin/McGraw-Hill.
Richmond, Gail Levin. (1997). Federal Tax Research: Guide to Materials and Techniques. New York: Foundation Press.
Taxation (Supreme Court Drama)
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 (1776783). 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 (1861865) 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 (1776783), 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 (1861865).
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.
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.
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.
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.
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.
Suggestions for further reading
Brown, Roger H. Redeeming the Republic: Federalists, Taxation, and the Origins of the Constitution. Baltimore: The Johns Hopkins University Press, 1993.
Brownlee, W. Elliott. Federal Taxation in America: A Short History. New York: Cambridge University Press, 1996.
Internal Revenue Service. [Online] http://www.irs.ustreas.gov (Accessed July 31, 2000).
Webber, Carolyn, and Aaron Wildavsky. A History of Taxation and Expenditure in the Western World. New York: Simon & Schuster, 1986.