Mr. McCormack
American Government
Central Dauphin High School
Chapter 16 – Financing Government
I. Taxes
A. The Power to Tax
1. The Framers listed the taxing power first among the Congressional powers
2. Congress uses the power primarily to raise funds for government activities
a. Congress may use its power for other purposes, however
b. In 2006, the Federal Government spent approximately $2.6 trillion, about $8000 for every person living in the United States
3. Benjamin Franklin once commented that “in this world nothing is certain but death and taxes”
B. Constitutional Limitations on the Taxing Power
1. Congress must exercise its power in accordance with the Constitution
2. There are four expressed limits on the power found in the Constitution
a. Taxes must be levied for public purposes, not for private interests
b. Congress can not tax exports
i. This limit resulted from the Commerce Compromise of 1787
ii. Congress can, however, prohibit certain exports
c. Direct taxes must be distributed among the states according to their populations
i. This limit resulted from the Three-Fifths Compromise of 1787
ii. Because the residents of the various states are not equally wealthy, direct taxes are now perceived as unfair
iii. Congress has not levied a direct tax, except for the income tax, outside Washington, D.C., since 1861
d. All import taxes must be uniform throughout the United States
3. Some indirect limits on the power were established in the Bill of Rights
a. Congress may not tax church services
b. Congress may not tax political speech
4. There are other limits on the power that are implied by the Constitution
a. The federal government can’t tax state or local governments in their public functions
b. The federal government can tax non-governmental functions, like selling alcohol
C. Current Federal Taxes
1. Income Tax
a. The first federal income tax was established in 1861 to finance the Civil War
i. The Supreme Court unanimously held that it was an indirect tax, not subject to the direct tax restriction, in Springer v. United States (1881)
ii. The tax expired in 1873
b. Another income tax enacted in 1894 was declared unconstitutional in Pollock v. Farmers’ Loan and Trust Co. (1895)
c. The Sixteenth Amendment authorized the income tax in 1913
d. The income tax is the largest source of federal revenue, some 44% of federal income
e. Features of the income tax
i. It is flexible, and rates are adjusted from time to time
ii. It is progressive – the more you earn, the higher percentage of your income you pay
iii. It is paid by both individuals and corporations
f. Individual Income Tax
i. Tax is levied on each person’s taxable income – gross income minus certain deductions and exemptions
ii. Exemptions are granted to each person ($3150 in 2005)
iii. Deductions are granted for certain expenses
1. Medical care
2. State and local taxes (but not sales tax)
3. Home mortgage interest payments
4. Charitable contributions
iv. Individuals must file tax returns by April 15th each year
v. Republicans cut taxes in 2001, 2002, and 2003
vi. Individuals pay taxes in six brackets ranging from 10% to 35%
vii. Most wage earners are subject to tax withholding
viii. Anyone who earns income that is not subject to withholding must send in quarterly payments
ix. Some workers get refunds when their returns reveal that more was withheld than was owed
x. Most Americans wind up paying about a third of their income in taxes
g. Corporation Income Tax
i. Corporations pay taxes on net income (gross income minus expenses)
ii. This tax is extremely complicated because of the many deductions allowed
iii. Corporate tax rates run from 15% to 35%
2. Social Insurance Taxes
a. The Federal government withholds taxes for three welfare programs
i. Old-Age, Survivors, and Disability Insurance (Social Security)
ii. Medicare – health care for the elderly
iii. Unemployment Compensation Program
b. Social Security
i. Currently, wage earners pay 6.2% of their income (up to $94,300)
ii. Employers contribute an equal amount
iii. Self-employed people pay 12.4%
c. Medicare
i. Currently, wage earners pay 1.45% of their income (no limit)
ii. Employers contribute an equal amount
iii. Self-employed people pay 2.9%
d. Unemployment Compensation
i. This is a joint federal-state program, so details are controlled by state law
ii. Payments are only made to workers who lose their jobs for reasons beyond their control
iii. Wage earners pay 6.2% of their income (up to $7000)
e. Social insurance taxes are regressive, not progressive
i. The rates stay the same regardless of overall income
ii. The poor pay a greater percentage of their total income than do the wealthy
f. Many people pay more for social insurance taxes than for the income tax
g. Surpluses from these taxes (the amount collected over what the programs need in a given year) are added to the government’s general fund
3. Excise Taxes
a. Excise taxes are levied on the manufacture, sale, or consumption of goods or services
b. Excise taxes have been used since 1789
c. The government taxes many common items
i. Gasoline
ii. Alcohol
iii. Tires
iv. Guns
v. Airline tickets
vi. Tobacco
d. Many taxpayers are unaware of these taxes because they are factored into the price of the items by their producers
e. Given the nature of the items taxed, excise taxes are sometimes called “luxury” taxes or “sin” taxes
4. Estate and Gift Taxes
a. Estate taxes are levied on the assets of the deceased
i. Most states levy “inheritance taxes” based not on the total assets, but on what individual beneficiaries receive
ii. Both estate and inheritance taxes are called “death taxes”
iii. The first $2 million of an estate is exempt from federal taxes
iv. Exemptions are given for state taxes and charitable bequests
b. Gift taxes are levied on gifts between living persons
i. These taxes were created to prevent people from avoiding the estate tax by giving away their property in anticipation of death
ii. Individuals may make up to $11,000 in tax-free gifts to an individual in a year
iii. Gifts between spouses are never taxed, regardless of value
c. Rates for estate and gift taxes are identical
i. In 2006, the lowest bracket was 18% for values up to $20,000
ii. In 2006, the highest bracket was 46% for values over $3 million
5. Customs Duties
a. Also known as tariffs, import taxes, import duties, or imposts
b. Most imports (more than 30,000) are “dutied”
c. Up to $800 of items may be brought tax free to the US by tourists
d. Other items (i.e. Bibles, coffee, bananas) are also duty-free
e. Custom duties were once the major source of federal revenue, but with the move toward free trade, they now amount to less than 1 percent of it
D. Taxing for Nonrevenue Purposes
1. Some taxes are designed to influence consumer behavior
a. These taxes are levied against goods or activities deemed harmful or dangerous
b. Many excise taxes (i.e. tobacco and alcohol) are based on this theory
2. Requiring the purchase of a license is an example of this taxing power
3. Recently these taxes have been intended more and more to encourage conservation
4. The Supreme Court upheld taxation for non-revenue purposes in Veazie Bank v. Fenno (1869)
II. Nontax Revenue and Borrowing
A. Nontax Revenues
1. The government accumulates about $30 billion each year from nontax sources
2. Much nontax revenue comes from interest paid to the Federal Reserve
3. The government collects fees for passports, copyrights, patents, trademarks, etc.
4. The government also collects usage fees (tolls, admissions fees, etc.)
5. The government sells or leases land and mineral rights
6. The US Mint makes a small profit (seigniorage) of about $2 billion on the production of coins
7. The Postal Service sells several hundred million dollars worth of stamps to collectors
8. Some people donate money to the government, especially when they die
B. Borrowing
1. Congress borrows to cover the costs of short and long-term crises (i.e. wars, etc.)
2. The government borrows to finance large-scale projects that could not be paid out of current income (i.e. construction of infrastructure, etc.)
3. The government now routinely spends more than it collects each year and finances these deficits with greater borrowing
4. The government has only generated a surplus for four years since 1969 (only 11 since 1930), and there is no reason to believe that surpluses will be generated for the foreseeable future
5. The national debt (accumulated amounts of all past deficits) is approaching $9 trillion
6. The government borrows money by selling bonds – a commitment to repay the price of the bond plus interest at some future date
7. The government can borrow on better terms than private individuals
a. The government can seize private assets to cover its obligations
b. The interest earned on government bonds is not taxed
C. The Public Debt
1. The public debt is the accumulated total indebtedness of the federal government
2. It is nearly impossible to visualize the sums needed to repay the national debt
3. It would take a stack of $1000 bills that was more than 500 miles high to pay it back
4. There is no Constitutional limit on the amount that may be borrowed, but Congress does impose a statutory limit
5. Congress routinely increases this limit whenever necessary
6. About one in ten dollars spent by the federal government goes to pay interest on the debt
III. Spending and the Budget
A. Federal Spending
1. Effects of Federal Spending
a. Prior to the Great Depression, federal spending seldom had much of an impact on the national economy because it was relatively small
b. Today, the government shifts trillions of dollars from certain areas of the economy into others, employs more people than any other organization, and is a huge component of GDP
2. Spending Priorities
a. The federal government has mandated certain benefits be paid to those who meet the eligibility criteria
i. These programs are called “entitlements” because their beneficiaries are legally entitled to those benefits
ii. Examples include food stamps, Medicare, Medicaid, and Social Security, the largest of all
b. Priorities can be identified by comparing the budgets of federal agencies
i. Department of Health and Human Services (2006) – $644 billion
ii. Social Security Administration (2006) - $584 billion
iii. Department of Defense (2006) – more than $500 billion
iv. Department of the Treasury (2006) - $441 billion
v. Department of Agriculture (2006) - $95 billion
vi. Entire Judicial Branch (2006) - $6.1 billion
3. Controllable and Uncontrollable Spending
a. About 80% of the federal budget is considered uncontrollable
i. . Entitlement spending
1. Considered uncontrollable because laws guarantee those benefits
2. In fact, Congress could control them by changing the eligibility requirements or stopping the benefits altogether
ii. Debt payments
b. Controllable (“discretionary”) spending includes all other spending
i. Defense
ii. Education
iii. Environment
B. The Federal Budget
1. The President and the Budget
a. Although the Constitution gives Congress the power of the purse, the President initiates the budget process each year
b. The federal government’s fiscal year runs from October 1 to September 30
c. The annual budget is just a plan that may be changed through the year
d. Budgeting begins about 18 months before the President submits his plan to Congress
i. Each federal agency prepares its detailed request for funds
ii. The Office of Management and the Budget reviews all requests, revises (usually lowers) them, and puts them together
e. The President’s budget proposals cover only the executive and judicial branches, although the requests for the judiciary are not reviewed by the OMB
f. Congress initiates its own budget
2. Congress and the Budget
a. The House and Senate Budget Committees and their subcommittees, with the help of the Congressional Budget Office, analyze and revise the President’s plan
b. The House and Senate Appropriations Committees also review the budget
c. Committees hold hearings with opportunities for testimony by lobbyists and the federal agencies
d. The Budget Committees propose a concurrent resolution in both chambers by May 15 which, if passed, serves to guide the other committees in their work
e. The final budget proposals are passed by September 15, and no appropriations can exceed the amounts contained in that budget
f. The Appropriations Committees actually initiate the spending bills, and they don’t always match expectations based on the budget
g. Congress has organized the federal budget into thirteen separate spending bills that should be passed by the start of the fiscal year
h. Congress may choose to pass continuing resolutions (allowing federal agencies to continue to function under the expiring budget) if a new budget is delayed past the start of the fiscal year
i. Should Congress fail to pass a continuing resolution the federal government would be required to suspend its operations temporarily