A tax is a compulsory payment levied by a government for its support and services. There are various kinds of taxes, such as taxes on the sale of goods, taxes on imported products (known as tariffs), and income taxes. Incomes taxes are levied against the earnings of estates and trusts, but especially against the earnings of corporations and individuals. The latter is known as an individual or personal income tax. Personal income taxes are most often associated with the federal government and the Internal Revenue Service (which is part of the U.S. Department of the Treasury), but personal income taxes can also be levied by state and local governments against their citizens or people earning income within their jurisdiction but living elsewhere.
Personal income taxes had a haphazard evolution prior to the passage of the 16th or "income tax" Amendment in 1912. A few states had a personal income tax before 1850. To help finance the Civil War, the federal government collected personal income taxes between 1863 and 1872. In 1894 Congress passed another personal income tax bill but this legislation was declared to unconstitutional by the Supreme Court. The high court ruled that in order to be constitutional, personal income taxes had to be levied in proportion to the population of the various states. In 1909 Congress passed a corporate income tax and in 1913 the 16th Amendment eliminated the proportional population requisite that stymied the 1894 legislation.
Present-day personal income tax rates in the United States are progressively based on an individual's personal income. Currently there are five rates based on taxable income: 15 percent, 28 percent, 31 percent, 36 percent, and 39.6 percent. This means that as one's income increases so does the percentage subject to being taxed. There are, however, numerous ways to lower one's taxable income. For instance, income earned as interest from certain types of municipal bonds is generally not taxable. Such an income item is called an exclusion. Income less exclusions results in one's gross income. Gross income less certain expenses, such as business or moving expenses, results in one's adjusted gross income. From an adjusted gross income a taxpayer may claim a wide variety of deductions. One of the most popular deductions is the interest paid on home mortgages, but deductions may also be taken for such things as state and local taxes and medical expenses. Another subtraction from adjusted gross income is an exemption. An exemption is a set dollar deduction given in the tax tables. In 1998 the exemption for each individual, spouse, or dependent was $2,700 per person. A husband and wife with one child were thus allowed to subtract $8,100 from their adjusted gross income in 1998. Also affecting income tax rates is the filing status or category. For filing purposes there are four categories: a single person, a married couple filing jointly, a married couple filing separately, and a head of household. The latter is a single person who maintains a household and who, under certain legally defined circumstances, is responsible for supporting others in that household. Each category is taxed at a different rate. Individual income tax returns must be filed by April 15 using Form 1040 as provided by the Internal Revenue Service (IRS).
Individuals, however, are not allowed to wait until the end of the tax year, April 15, to pay their entire tax bill. The IRS requires payments to be made throughout the year. If by April 15 one has paid more than what is owed, then a refund from the government is in order. If by April 15, however, money is still owed, then to avoid interest penalties, the balance must be submitted when the tax form is filed. Personal income taxes are collected by the government in two ways throughout the year. If an individual works for wages or a salary, taxes are deducted from each paycheck by the employer and sent to the government. This is referred to as one's withholding tax or simply withholding. The government does not pay interest on the withholdings it collects and holds throughout the year. People who do not work for wages or for a salary but are paid in other ways must file an estimated tax return by April 15 for each upcoming year. They must then make quarterly tax payments (April 15, July 15, October 15, and January 15) based on their estimated income. Anyone who earns income but does not pay a withholding tax is required to file an estimated return. Income earners who are self-employed, work as consultants or on a contractual basis, or who have a substantial income from dividends, investments, or capital gains often fall into this category. It is also possible to pay the entire estimated tax at the beginning of the tax year. People in this category who severely or purposefully underestimate their income may be subject to a penalty.
Over the decades the personal income tax code has been changed, amended, revised, and reformed countless times, but it has nevertheless always expanded to cover more people and lessen their deductions. When the personal income tax was instituted in 1913, fewer than I percent of working people filed returns. By 1940 this figure had risen to 11 percent and by the end of World War II virtually all working people were paying a personal income tax as they do today. The Tax Reform Act of 1986 reduced tax rates and increased the size of personal exemptions but also restricted deductions and exclusions. The next major piece of tax legislation was the Taxpayer Relief Act of 1997, which among other things instituted the Roth IRA, a child tax credit, new regulations on gains from the sale of a personal residence, new capital gains provisions, educational individual retirement accounts, new regulations on home-office deductions, a welfare-to-work credit, and a host of other changes and innovations.
There is growing but not yet overwhelming sentiment that the personal income tax code has become too burdensome, too political, too unfair, too complicated, too abused, too manipulative, too full of loopholes and special provisions, and used for too much "social engineering." Some people feel that instead of continually revising the old system, the only solution is to abandon it in its entirety and replace it with something else. This "something else" usually takes two radical but simple forms—a flat tax or a national sales tax. A flat tax, as envisioned by Senator Dick Armey of Texas and businessman Steve Forbes, would eliminate all deductions and everyone would be taxed at a flat rate of 20 percent above a personal exemption of $11,000 per individual and another $5,000 exemption per child. After two years the rate would fall to 17 percent. There would be no additional taxes or higher rates on dividends, interest, or capital gains. Thus an individual earning $50,000 annually would pay a personal income tax of $7,800 ($50,000 $11,000 = $39,000 × .20 = $7,800). Simplicity is the keyword Armey's plan and he boasts that everyone's return could be filed on a postcard.
A national sales tax as proposed by Representative Bill Tauzin of Louisiana would scrap all individual and corporate income taxes. In their stead would be a 15 percent tax on the sale of all goods and services including government purchases, homes, and retail level financial transactions. A 15 percent tax credit would be provided for poor working families. A family of four whose income is below the poverty level would thus receive a tax credit of nearly $2,500. Tauzin's plan is even simpler than Armey's—there would be no tax forms, no tax filing deadlines, and no IRS. Many analysts feel, however, that a flat tax would favor those earning over $300,000 and adversely affect poor working families, while a national sales tax would favor the rich and the poor at the expense of middle-income families.
[ Michael Knes ]
Adams, Charles. Those Dirty Rotten Taxes: The Tax Revolts that Built America. New York: Free Press, 1998.
Carson, Gerald. The Golden Egg: The Personal Income Tax — Where It Came From, How It Grew. Boston: Houghton Mifflin, 1977.
Dowd, Ann Reilly. "Get the Facts on Tax Reform." Money, January 1998, 86-87.
Sease, Douglas R., and Tom Herman. The Flat-Tax Primer. New York: Viking, 1996.
Turville, Mary A. "Making Sense of the Taxpayer Relief Act of 1997." National Public Accountant 42, no. 10 (December 1997): 18-24.