IMPORTANCE OF INCOME TAX
I. Income Tax (most important source of Rev) system plays a central role in:
a. Raising Revenue to Finance Gov’t – estimate: Income tax produces 59% of Fed Rev and over 40% of State Rev; Individual income tax finances 49% of Fed Rev.
i. High percentage of total tax comes from the wealthy. Those in upper 1% of population account for 30% of nations’ wealth and 15% of its income. Another way we fund gov’t is through debt.
b. Politics – Tax reforms used to promote policy – major issue for political parties.
c. Tax considerations affect every part of our lives – it is key to whether we buy or not real estate; alimony/child support; corporate/partnership; personal injury; criminal tax evasions, wealth test to conduct investigations.
d. Malpractice – Basically, you have to know when to call a tax specialist.
e. Economic Consequences – Inc tax has enormous effect on allocation of resources in our country.
1. Home ownership vs. renting – ownership is encouraged
2. Health care reform – health insurance can be provided tax free under certain circumstances
i. Much of the complexity of tax law is attributable to provisions and tax breaks designed to encourage particular kinds of economic activity. Tax cuts, and tax breaks are politically smart ways to allocate funds to certain areas of society w/o having to take the politically unpopular move of approving a huge tax increase & allocation to that area.
1. Tax Expenditure Budget– quantifies how much potential revenue the gov’t has lost by allowing these deductibles by equating tax benefits w/ direct subsidies. Doing things through tax codes is more appealing to Congress than through direct spending (it’s all a matter of getting political votes). Tax Expenditures are a more politically viable way for politicians to allocate funds to certain areas of society than raising actual expenditures.
f. Finally, it’s important b/c we’re all TPs.
GOALS OF INCOME TAX
I. Raising Revenue for the Gov’t (see supra).
II. Fairness –taxes are based upon one’s “ability to pay.” Involves 2 concepts:
a. Vertical Equity – take more from the rich and less from the poor, in either actual dollars or in a greater percentage. A flat tax is not enough. A progressive rate structure is needed to achieve vertical equity.
i. Progressive Rate Structure IRC § 1 – reflects principle of vertical equity. As one’s income increases the proportion of income that one pays as a tax also rises. Progression is designed to reduce the inequalities of income associated w/ our largely free market system.
b. Horizontal Equity – People similarly situated should be taxed alike – equal incomes should pay equal amounts. Income comes from different kinds of sources and may be taxed differently. E.g. TP1 gets $50K cash salary. TP2 gets $40K salary plus use of a car valued at $10K. It’s only fair that they pay the same since they’re similarly situated.
III. Economic Rationality: Economic Effects / Incentives– Certain types of economic activity
an on apportioned “direct” taxes on rent, dividends, and interest.
IV. 16th Amendment 1913 – “The Congress shall have the power to lay and collect taxes on incomes, from whatever source derived w/o apportionment among the Several States, and w/o regard to any census or enumeration.”
a. Followed by a modest tax increase on the rich.
V. World War I – led to a dramatic expansion of Income Tax to create war $. Post WWI, rates dropped as federal spending dropped.
VI. World War II – the income tax became and remains a mass tax – one imposed on all persons.
VII. Marginal Rate High Water Mark – in early 60’s some levels of income were taxed at 91% w/ deductions.
VIII. Income Tax as a Social Tool – used to achieve particular economic and social policies. I.e., tax breaks for the purchase of business equipment to stimulate the economy
a. Progressive Tax Scheme – one under which rates rise as income rises. Thus, high-income TPs pay a higher proportion of their income taxes than do lower-income TPs.
i. Marginal Tax Rate – rate applicable to the last dollar of income earned by TP.
IX. Tax Reform Act of 1986 – reduced maximum marginal rate to 28%. Today, 2003, top marginal rate is 35%.
