These days, the average US worker works until mid-April just to pay off the taxes he or she owes at local, state and federal levels. That seems like a lot. In the decades since World War II, government has assumed a much greater role in the economy than ever before. Many say that it plays too big a role, that government has become a monster with an insatiable appetite for our hard-earned money. Nevertheless, it can't be denied that before government became so heavily involved in the workings of the economy, poverty was deeper, depressions were more severe, and the health and safety of workers was in greater peril.
There are three major ways that government influences the economy:
Government's role in the economy is always the biggest and most contentious part of political debate. The sides of the debate about government's role are generally termed the "Left Wing" and the "Right Wing". The Right Wing's demands for greater freedom and less governmental interference and control are countered by the Left Wing's calls for more equal distribution of wealth and better protection of health and the environment. The debate goes on, and on, and on, through the muddled ebb and flow of the modern mixed economy.
One thing we know for sure about taxes, though, is that nobody wants to pay them. Taxes on goods increase their price. Taxes on wages decrease the amount that consumers are able to spend. Taxes on profits lower the funds businesses have available for new investment. This pervasive fact has led to the modern strategy of "broad-based" taxation. The general logic is that since taxation is painful to everybody, government will spread the tax burden out over as many different sources as it possibly can.
How do we decide whether taxes are fair? Two general criteria are used: the principle of ability to pay, and the principle of benefits received. The benefits-received principle asks for a higher tax payment from people who enjoy more benefits from government; and example would be the charging of a higher property tax to people living closer to good schools and public transportation facilities.
Taxes are called "progressive" when they place a greater burden on people with higher income. They are called "regressive" when the place a greater burden on the poor. Thus, an income tax that charges higher rates to higher-income people is a progressive tax, while a sales tax, which charges the same tax rate regardless of the buyer's income level, is a regressive tax. Since regressive taxes seem unfair, we might be led to wonder why they are so popular! One reason is that a tax that levies a small amount on the purchase of very common goods is an easy way to raise a lot of revenue without people noticing it as much.
The complexity of tax policy in modern society is almost beyond imagining. You might think, for example, that a by these criteria a property tax would be a much better tax than a sales tax. Property values are a direct result, after all, of benefits received by the users of nearby public services -- and, people with a greater ability to pay generally own higher-priced property. Sales taxes, meanwhile, place a greater burden on the poor, and slow down the overall economy by adding to prices? Yet, odd as it may seem, many states have been deciding in recent years to rely more heavily on sales taxes, and relieve property taxes!
Why is that? Because tax policies are established by elected legislators who are subject to political pressures. The payers of sales taxes tend to be a large, diverse, unorganized group. Property owners, on the other hand, tend to be a smaller, more organized group, each of whom has a higher personal stake in the issue.
These facts of political life create an all-but-unstoppable tendency for the tax system to become more complicated all the time. Since taxation burdens everyone, then a little bit of relief from taxation for a particular locale or industry can be used as a political favor. Such political horsetrading goes on all the time, and its legacy is the income tax system. The full text of federal tax regulations, called the "Tax Code" is many volumes long and gets bigger every year. An entire industry is devoted to helping bewildered citizens and businesses figure out how much tax they must pay.
Many people claim that the Federal income tax is illegal for various reasons. If, when they fill out their annual tax returns, citizens fail to declare taxable income, they can be prosecuted for tax evasion. (This is actually the means by which legendary racketeer Al Capone and other organized crime figures were caught and sent to jail.) This creates an interesting legal problem. The Fifth Amendment to the US Constitution protects citizens from being compelled to provide self-incriminating evidence in any criminal prosecution. Yet, when people are convicted of tax evasion, the tax return that they were compelled to file is used as evidence against them. This does appear to violate the Fifth Amendment right against self-incrimination. However, the US Supreme Court has ruled that not to be the case. As early as 1927, the Court has upheld convictions of citizens for failing to file a tax return.
The issue of taxation seems to pose yet another dilemma to the "dismal science" of economics. The political nature of tax policy seems to lead us to make unfair and inefficient choices in how we fund government services. Yet if government does not provide these services, the market will only provide them in ways that are grossly unfair and inefficient! So far, we have just managed to muddle through, somehow, adding new reams to the tax code every year. Do we have any other choice?
Background Questions