According to the Preamble to the Constitution, the purpose of the federal government is “…to establish Justice, insure domestic Tranquility, provide for the common defense, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity.” These goals are achieved through federal government taxing and spending.
Federal spending can be broken down into two primary categories: mandatory and discretionary. Mandatory spending is required by existing laws creating things like Social Security. Mandatory spending represents nearly two-thirds of annual federal spending.
Discretionary spending is voted on by Congress in their annual appropriations process. Generally, Congress allocates over half of the discretionary budget towards national defense and the rest to fund the administration of other agencies and programs.
What does our federal income tax pay for? In 2022, the federal budget broke down like this: 19% Social Security; 15% Health; 14% Income Security; 12% National Defense; 12% Medicare; 11% Education and Training; 8% Interest; 4% Veterans Services; 2% Transportation; 2% Government; 1% Other.
Federal revenues come from a variety of sources. The largest is individual income tax, 52%. Social Security and Medicare make up another 34%. The other 14% comes from corporate income tax, excise tax, estate tax, customs and tariffs, land leases, admission to national parks, etc. When our revenues are less than our spending, the government borrows and we have a deficit.
According to the OECD (Organization for Economic Cooperation and Development) the United States actually collects less in taxes than most other nations, 26.6% of our GDP. The international average is 34.1% of GDP.
Income taxes in the United States began in the 1861 to fund the Civil War, and then were repealed in 1872. Prior to and after the Civil War, tariffs on imported goods and excise taxes on products like liquor funded the government.
In 1913 the 16th Amendment to the Constitution was ratified. “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.”
Income tax was set up to be progressive, because the tariffs and excise taxes on products were terribly regressive, meaning lower income people paid a much higher percent of their income to support the government. Progressive taxes divide income into parts called brackets, with each bracket paying a different rate. If part of a person’s income falls into the top bracket, only that portion pays that rate.
Congress in 1913 enacted 1% tax on net personal incomes above $3,000, with a 6% surtax on incomes above $500,000. By 1918, the top rate of the income tax was increased to 77% on income over $1,000,000, equivalent of almost $20 million today, to finance World War I.
In 1932 the top marginal tax rate was increased to 63% during the Great Depression and steadily increased, reaching 94% in 1944 (on income over $200,000, equivalent of $3 million today). During World War II, Congress introduced payroll withholding and quarterly tax payments.
Income tax now is paid by almost two-thirds of the population. The lowest-earning workers, especially those with dependents, pay no income taxes. We each receive a standard deduction to subtract from our total income. Child tax credits and the Earned Income Tax Credit also reduce taxable income.
Taxes continue to be controversial, and there are lots of suggestions for changing the system. Should we all pay more so we don’t have a deficit? Should corporations pay more, because they benefit the most from national defense and trade policies? Should we switch to a flat tax rate? National sales (consumption) tax? Value added tax? Each of these has drawbacks but will continue to be debated.
For now we just need to download that Form 1040 and figure our share.