Who and what should be taxed?
In 2012, the federal government collected about $2.3 trillion — that is, $2,300,000,000,000 — in tax revenue from its citizens. Such an enormous sum raises an obvious question: what does the federal government do with it all?
Most of the federal government’s tax revenue comes from four sources. Individual income tax is the largest source, followed by payroll taxes and the corporate income tax. The fourth main source is excise taxes. Figure 12.4A shows these sources, along with the share of total revenue provided by each type.
Even with these four major taxes, the government typically does not take in enough revenue to cover all its expenditures. This gives rise to the federal deficit, the shortfall between tax revenues and government expenditures in any given year.
To make up this difference, the government bar· rows money. Federal borrowing takes place through the sale of government bonds, which include Treasury bills, savings bonds. and other government-issued certificates of debt. When the government sells a bond to an investor, it is taking on a debt that it promises to repay with interest in the future.
Selling government bonds to make up for a federal deficit adds to the national debt. however. The national debt is the total amount owed by a nation’s government as a result of borrowing.
Every year, the federal government draws up a budget to determine how it will spend its revenues. Like all government budgets, it is based on a fiscal year, rather than a calendar year. A fiscal year is a 12·month accounting period. The federal fiscal year begins on October I and is identified by the year in which it ends. Fiscal year 2013, for example, ended on September 30, 2013.
In the federal budget, spending is divided into two broad categories: mandatory and discretionary. These broad categories and their subdivisions are represented in the circle graphs in Figure 12.4B.
Mandatory spending is spending that is fixed by law. The only way for Congress to change the amount of money allocated to mandatory spending is to enact new legislation.
The two main categories of mandatory spending are interest on the national debt and entitlements. Entitlements are programs through which individuals receive benefits based on their age, income, or some other criteria. Entitlement programs include Social Security, Medicare, and welfare. The amount of money spent on such programs depends on the number of people who sign up for them. As the bar graph in Figure 12.4B indicates, the percentage of federal revenue dedicated to mandatory spending has grown significantly over the past several decades.
The other main category of spending. discretionary spending, is made up of expenditures that may be raised or lowered as Congress sees fit. As mandatory spending has grown in recent years, the share of revenue available for discretionary spending has shrunk. By far the biggest chunk is spent on national defense. The rest supports government funding for education, scientific research, health care, and foreign aid, among other activities. A portion also funds federal grants to state and local governments.
Like the federal government, state and local governments get most of their money from taxes. However, state and local officials face certain problems in raising revenue that the federal government does not face.
Some state constitutions, for example, prohibit state lawmakers from enacting certain types of taxes. Seven states, for instance, ban individual income taxes. Other states limit how much certain taxes can increase from year to year. In Massachusetts, for example, property taxes cannot increase by more than 2.5 percent a year. Such restrictions can be changed only if voters approve amending the state constitution.
In addition, citizens playa much larger role in tax policy at the local and state levels than at the federal level. Many states and localities require voters to approve tax hikes through tax referendums — direct popular votes on an issue. Some states, such as California. require a two-thirds majority of voters to approve increases in many types of taxes.
In part because of these limitations. state and local governments rely on certain revenue sources that are not used at the federal level. such as property and sales taxes. Many states also run lotteries, large, scale legal gambling games organized to raise money for a public cause. As of 2013, 43 states, along with the District of Columbia, U.S. Virgin Islands, and Puerto Rico, held lotteries. The first graph in Figure 12.4C shows the percentages of state and local revenue that come from various sources.
The second graph in Figure 12.4C shows categories of spending by state and local governments. Unlike the federal government, which spends the bulk of its revenue on entitlements and defense, state and local governments devote large shares of their revenue to services that directly affect young people and their families.
The most important of those services is education. As of 2012, nearly 50 million children were enrolled in public elementary and secondary schools throughout the United States. The average amount spent on each of these students was $11,467 per year. About 88 percent of that money came from state and local governments. Law enforcement and fire protection are two other responsibilities relegated mainly to local governments. In many communities, police protection is the second largest public expense after education.
State and local governments also fund a variety of health and social services, often with assistance from the federal government. Typical examples include public health clinics for low-income families, health care centers for the mentally ill, and childcare for low-income working families.
Many other services are funded at the state and local levels. For example, state and local governments spend money to build and maintain roads and bridges. They create and maintain parks and playgrounds for the public to enjoy. They also fund public libraries, civic auditoriums. and museums.
All these services have been developed in response to public demand. The ever-present challenge is finding the money to pay for what the public wants. Because many state constitutions require balanced budgets, states that run short of funds must either raise taxes or cut programs. Either way, people are likely to object.
The fact is that although most people want the services that government provides, few people are happy to pay the taxes needed to fund those services. Former U.S. senator Russell Long once poked fun at this contradiction by reciting this jingle:
Don’t tax you.
Don’t tax me.
Tax that fella behind the tree.
Taxes may not be a big issue in your life yet. But once you begin earning a regular income, they will be. You may be shocked when you get you r first paycheck to see how much is deducted in income and payroll taxes. At that point, the question we started with- — Who and what should be taxed? — may seem more important. And it should. No matter what form they take, in the end, all taxes are paid by individuals just like you.