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Government
GOALS
• Describe where the federal goverri
ment gets the money it spends.
• Explain principles and types of
taxation.
KEY TERMS
sales tax
property tax
excise tax
estate tax
glfttax
business or license tax
customs duty or tariff
Sources of Government Revenue
Approximately 20 percent of all income in the United Stares flows to the federal
government each year. The government receives funds from taxes and borrowing.
The borrowing is in the form of government bonds, which will be discussed later.
The federal government receives the largest part of the funds it spends from
income taxes, which account for 39 percent of the federal government’s revenue.
Social Security and Medicare taxes bring in 32 percent of the total. Another
13 percent comes from corporate income taxes. Other types of taxes and fees
account for 7 percent of the total. The remaining 9 percent is borrowed to cover
the deficit.
Social Security and Medicare
Both employers and employees pay Social Security and Medicare taxes. The
amounts withheld for these taxes appear on your paycheck stub.
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SJ Taxes and Government
:ontributions to ocn
cirity Under FICA regula
ions, workers \‘ages are taxed at a
ate of6.2 percent. This percentage
s collected on gross income up to
i maximum level chat is adjusted
or inflation each year. In 2008, the
:flj\iflfljm income taxable for
ocial Security was $102,000.
Sources of Federal Government
Income for 2OO
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39%
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customs, estate,
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taxes 7%
itt, and
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Contributions to
edicare An additional
.45 percent is taken on all earned
ncoine to pay tor the Medicare
irogram. i\dding these percentages
ogether. the total most people pay
or Social Security and Medicare is
.6S percent of gioss income.
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Set urity, Medicare, and
ii nempIo merit and other
it’tireiuuent taxes 32%
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‘our Employer’s Contribution Employers match employees’ payments
or Social Security and Medicare. Eor each dollar you earn tip to a maximum
mouiit, I 53 ccii ts goes to the government for these taxes. I lalfcomes from you.
Che other half conws roin your employer. If you are self-employed, the govern
men t requires you to pay the cnn re 15.3 cents, although half of your payment can
ie subtracted from your adjusted gross income to reduce your income taxes.
HECKPOINI
What are the major sources of revenue for the federal government?
.
.
Jassafyrng Taxes
A good way to understand how you are taxed is to learn different ways in which
taxes are classihed. Three common ways are to group taxes according to their
principles, the share ot income they take, and the way in which they are collected.
Principles of Taxation
The principles of American democracy demand that every taxpayer should be
treated equally under the law. This does not mean that all taxpayers should pay
the same amount of tax. Principles of taxation suggest that some should pay
more than others.
Under the benefit principle, those who use a good or service provided by the gov
ernment should pay for it. Toll roads are an example of this principle. Those who
drive on the road pay the tolls.
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Taxes
Under the abi1iy-to-pay principle, those who have larger incomes should pay
a larger share of what they receive. Federal income taxes are an example of this
principle. As people’s taxable income grows, the rate of this tax increases from
10 to 35 percent. Many taxes do not fall clearly under either of these principles of
taxation.
Taxes and Income
Taxes are classified in three ways depending on the share of income they take of
different levels of yearly income.
Progressive taxes take a larger share of higher incomes. Federal income taxes are
progressive for most taxpayers. Ray’s income tax rate, for example, increased from
15 to 25 percent when his earnings went from $28,000 to $45,000 per year.
Regressive taxes take a smaller share of higher incomes than of lower incomes.
Many state and local taxes are regressive. Suppose that Louisa earns $16,000 a year
compared to Ray’s $45,000. Both buy a used car for $10,000 and pay an 8 percent
sales tax. The $800 tax is S percent of Louisa’s income but only 1.8 percent of
Ray’s.
Proportional taxes take the same share of all incomes. If all people were taxed
10 percent of all their income, this would be a proportional tax. No perfect
examples of proportional taxes exist in our economy.
A person with a high income can pay more dollars with a regressive tax than a
person with a small income, Remember that the number of dollars taken in tax is
not what makes the difference. Whether a tax is regressive, progressive, or propor
tional depends only on the percentage of different incomes that it takes.
How Taxes Are Collected
The government must collect taxes in the most effective and efficient way pos
sible. There are several methods of tax collection.
Direct Taxes Direct taxes such as income and property taxes are paid directly
to the government.
ndirect Taxes Taxes included in the cost of a good or service are indirect
taxes. For example, part of the rent tenants pay is used by their landlords to pay
property taxes.
Pay-asYou-Earn Taxes Taxes that are paid as you earn income are pay-asyou-earn taxes. Federal withholding is an example of this type of tax payment. As
you receive a paycheck, the government takes its cut.
Types of Taxes
Most people are familiar with income taxes and sales taxes. But there are other
types of taxes that consumers sometimes have to pay.
ncome Taxes Most states and some cities impose income taxes patterned
after the federal system. State and local income taxes may be withheld from your
paycheck.
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53 Taxes and Government
As with federal tax, you are responsible for calculating the amount of income
tax you owe. Information you provide on your Form W-4 includes information
your employer needs to determine state and local withholdings.
The most apparent difference between state, local, and federal income taxes is
the tax rate. State and local income tax rates are much lower. Most state income
tax rates are less than 8 percent. Local government income taxes are typically
between 1 and 2 percent.
Sales Taxes Taxes added to the price of goods and services at the time
f purchase are sales taxes. These taxes are a percentage of the cost of each
purchase. Some produces, such as food or medical devices, are not subject to sales
tax in many states. A sales tax is probably the first tax you ever paid. When you
buy a soft drink, magazine, pair of shoes, or a computer, you pay sales taxes. The
tax amount appears on your sales receipt. Funds collected from sales taxes are
normally divided between state and local governments.
Property Taxes Taxes on the value of real property are property taxes.
Government workers estimate the value of a piece of land, structure, or other type
of property. The tax is a percentage of that value. These taxes are most often used
by local governments and school districts.
Often property taxes are added to your home loan payments. The financial
institution that gave you a mortgage collects your taxes from your monthly
payments to pay your property taxes for you.
Excise Taxes An excise tax is collected on the sale of specific goods and
services. States place excise taxes on items such as tobacco, gasoline, and alco
holic beverages. The federal government imposes excise taxes on oil products,
firearms, and air travel. Unlike sales taxes.
excise taxes are included in the price
charged to consumers. When you pay for a
gallon of gasoline, the price includes both
federal and state excise taxes.
Estate and Gift Taxes When a per
son dies, there may be estate taxes on the
property that is received by those legally
entitled to the estate. Only estates higher
than a certain amount are taxed.
Gift taxes are taxes that the giver of
gifts may pay. Federal law allows people
to make some gifts that are not taxed.
The maximum value of untaxed gifts was
$12,000 per year in 2008. This amount
is periodically increased to account for
jnflation.
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Do you think it’s fair to make gift givers pay taxes? Why or why not?
Business and License Taxes To operate certain kinds of businesses,
companies or individuals must have a license, permit, or stamp. A business or
icense tax is paid for this certifIcation, which may be accompanied by a test. For
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Taxes
instance, to be licensed to practice medicine in your state, your doctor had to
pass some certification tests and pay a fee.
Customs Duties and Tariffs
To control the flow of products that are im
ported into the United States, customs duties or tariffs are imposed on some
imports. This results in items from abroad being sold at higher prices than they
otherwise would be.
CHECKPoINT
What is the main difference between state or local taxes and federal income taxes?
Xtra!
www cengag.comfinance/m*fter
1. What is the largest source of federal government revenue?
2. Which governments benefit from sales taxes?
3. What are the principles of taxation?
4. What is the difference between sales and excise taxes?
5.
CONSUMER ACTION Revisit this feature on page 174, Raj is torn between buying cheaper gas
or higher-priced gas that supports state programs. Write a paragraph advising Raj to purchase
gasoline either in or out of state. Explain your reasons for your advice.
6. Suppose you could vote on a proposal for a property tax increase to raise money for local law
enforcement. You own property worth $100,000, and the current property tax rate is 2 percent.
If this proposal passes, the new property tax rate would be 2.5 percent. Would you vote for the
increase? Why? What would it cost you if the proposal passed?
DECISION
MAKING
PROJECT
SEARCH
Sw
SELECT
SPECWY
STUDY
SIFT Fill out a Form 1040E2 for the student using Form W-2. Assume another person
claims the student as a dependent and that there is no taxable interest income, un
employment compensation, or earned Income credits to report. What is the taxable
income? Does the student have to pay the IRS or can the student expect a refund?
How can this return be filed online?
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