Around the middle of spring, you’ll begin to hear the moans and groans of working adults needing tax help and complaining about income taxes. Sure, we all know that it’s legally required, but do we really know why a substantial chunk of our income is being handed over to the government?
Regardless of whether we give a nod of approval or think it is totally absurd, understanding the true purpose of taxation is necessary for all taxpayers. Why do we pay taxes? There are plenty of reasons. From funding retirement programs to paying government workers, taxes help keep our country running. Continue reading below to find out more about why we pay taxes to the government.
Why We Pay Taxes: An Overview
Why do we pay taxes? The simplest reason is that the municipal, state, and national governments implement tax laws, and taxpayers’ money pays for government services of all kinds.
These governments are comprised of a few parts: the legislators (those who make laws), executives (those who enforce laws), judges (those who decipher laws), and many others. The money received from taxes pays individuals who work for the government, as well as for public programs like education and infrastructure like roads.
Although a legal requirement, paying taxes is also considered a civic duty. If you neglect to pay, the mediating body that oversees taxes (the Internal Revenue Service, or IRS) will require that you do so — otherwise, you might face penalties such as hefty fines or jail time.
Taxes come in a number of forms. Income tax is the amount you pay when working at a job. Depending on your income, a percentage of that money is withheld, meaning it’s removed from your paycheck and sent to the government. When you purchase items at a store, a sales tax is typically added to the price. Sales tax is a percentage of the cost of the good charged at the store. Owning property also requires you to pay property taxes on its assessed value.
Types of Taxes: Federal, State and Local
When it comes to taxes, there are three types: federal, state, and local. Why do we have to pay taxes to each level of government? Each level uses these taxes in different ways to fund governmental operations. Below, we’ll go over each level of government and how they collect taxes.
The 16th Amendment was ratified on February 3rd, 1903, and gave Congress the power to impose a federal income tax. However, tax collection isn’t a new concept. Taxes have been collected for thousands of years by ancient civilizations, such as the Romans and Egyptians. Today, taxes serve as the largest source of revenue for the United States government and are used to fund social programs, our nation’s security, and more. In the fiscal year of 2017, the Tax Policy Center found the U.S. government collected roughly $3.3 trillion in taxes, with:
- 9 percent of those taxes coming from individual income taxes
- 35 percent coming from social insurance (payroll) taxes
- 9 percent coming from corporate income taxes
- 5 percent coming from excise taxes, and
- 6 percent coming from other sources, such as estate taxes, tariffs, and earnings from the Federal Reserve’s holdings
States also collect their own taxes. Some reasons why we pay taxes at the state level is to fund programs and projects such as schools and roads. For fiscal year 2016, the Urban-Brookings Tax Policy Center found the following breakdown for state government general revenue:
- 4 percent of revenue came from intergovernmental transfers
- 1 percent of revenue came from sales taxes
- 3 percent of revenue came from charges and miscellaneous sources
- 18 percent of revenue came from individual income taxes
- 8 percent of revenue came from other taxes
- 4 percent of revenue came from corporate income taxes.
Overall, in fiscal year 2016, states collected around $1.9 trillion of general revenue, with $923 billion coming from sales, income, and other taxes.
Intergovernmental transfers include funds transferred from other governments, typically the federal government.
Charges and miscellaneous sources typically include tuition that is paid to public state universities and colleges, toll fares for bridges and highways, and money paid to public hospitals.
Other taxes typically include revenue collected from estate taxes, license fees, and severance taxes, according to the Tax Policy Center. States also levy taxes on select sale items, such as tobacco, alcohol, and gasoline.
Finally, municipal governments collect their own taxes, such as the town, city, county, township, or school district you live in. Most local government revenue is collected from property, sales, and income taxes, whereas most federal revenue comes directly from personal income taxes. Here is the breakdown of local government general revenue in fiscal year 2016, founded by the Urban-Brookings Tax Policy Center:
- 1 percent of revenue comes from intergovernmental transfers
- 8 percent of revenue comes from property taxes
- 6 percent of revenue comes from charges and miscellaneous sources
- 2 percent of revenue comes from sales taxes
- 4 percent of revenue comes from other taxes
- 0 percent of revenue comes from income taxes
Local governments in 2016 collected over $1.6 trillion of general revenue, with $677 billion coming from sales, individual income, property, and other taxes. Aside from property taxes, sales taxes, and intergovernmental transfers from federal and state governments, local governments collected revenue from parking meter fees, water fees, sewage fees, and more.
How Does the Government Use Our Taxes?
A major reason why many Americans asked themselves, “Why do we pay taxes?” is because they don’t know where their hard-earned money goes. Once the government takes money out of your paycheck, you may see it in a few public works projects such as paved roads and your Social Security check when you retire. But where does the rest of your money really go? Take a look below to find out!
Each year, the federal government uses your money to go to major public works programs and national defense to keep our country safe and citizens healthy. On USAspending.gov, you can find a complete breakdown of where your tax dollars go. In fiscal year 2018, here are the top five areas of spending by the federal government:
- Medicare: $1,059,508,772,650
- Social Security: $1,039,099,908,077
- National Defense: $995,628,286,613
- Health: $696,462,832,407
- Income Security: $548,423,716,755
As you can see, that’s a lot of money being spent, and those categories are only five of the twenty listed on USAspending.gov.
While the federal government uses your tax dollars to take care of large national programs, state governments use tax dollars for elementary, secondary, and higher education, transportation, Medicaid, public housing, and more. The National Associate of State Budget Officers released a State Expenditure Report for fiscal years 2016-2018. Here’s what their report found:
- For the first time in history, state spending exceeded $2 trillion
- Elementary and secondary education spending remains the largest category of general fund spending
- Medicaid spending in 2018 jumped $41 billion from 2017 to $603.2 billion
- Public assistance grew 0.7 percent, and includes spending on cash assistance programs like the Temporary Assistance for Needy Families program and Supplemental Security Income (SSI) and General Assistance
Local government spending is more visible than state and federal spending, as most of their revenue is spent on tangible services. For example, local governments are in charge of sewers and running water, electricity, waste removal, and school transportation. When local governments collect taxes, they use the money to fund public works programs like these. In 2016 alone, local governments spent roughly $1.6 trillion to fund many public works and welfare programs, such as corrections, police, firefighters, libraries, parks, and more.
For example, the Urban Institute found that state governments are responsible for a majority of highway construction and repairs, while local governments focused more on roads and streets. This includes repaving damaged roads, snow and ice removal, maintenance, and safety. In total, $175 billion was spent on highway and road operations by state and local governments in 2016.
Who Decides How Taxes are Used?
Now that you know the answer to “Why do we pay taxes?” you’re probably wondering who gets to decide on how taxes are used. Below, we’ll go over how decisions are made at each level of government.
Each year, the President has to create a budget. In order to create a budget, the President must create a detailed plan, and funds are collected from taxes and borrowed money in the form of bonds, notes, and Treasury bills. USA.gov explains the process of creating a budget, which goes as follows:
Step 1: Department and agencies submit proposals, and begin working on them 1 ½ years before they’re due. They then send their proposals to the President to help with his/her budget request.
Step 2: The President submits their budget plan by the first Monday in February, usually in a State of the Union Address, and gives the proposed budget to Congress.
Step 3: The Senate and House of Representatives create budget resolutions by analyzing the President’s proposal. During this process, they bring in outside experts for expert advice on how the proposal will impact various industries.
Step 4: The House and Senate both create appropriations committees to distribute funding, which is sent to twelve subcommittees who oversee different governmental agencies, who draft bills setting the funding for the agency they overlook.
Step 5: Once the House committees draft bills, they send it to the entire House for approval. Once the House approves it, the budget proposal goes to the Senate for approval. Both chambers must vote on the same exact bill, and if approved, it is sent to the President.
Step 6: Once approved by Congress, the bill will be sent to the President for his/her signature. If the President approves, it will be enacted into law. However, if the President vetoes the bill and a budget isn’t approved by the deadline, a government shutdown can occur, which will cease funding for many federal programs.
At the state level, residents of the state vote for state legislatures. It’s these legislators who get to decide what to do with revenue collected from taxes. Legislatures get to determine where tax money can be spent, whether for education, public works projects, healthcare, public assistance programs, or corrections. The National Conference of State Legislatures created a Tax Policy Handbook for State Legislatures that outlines their duties and provides information on the various categories of where taxes can be levied.
Local governments are composed of representatives elected by city or town residents. These elected representatives sit on city commissions, councils, and boards. It’s these groups that decide on how local taxes will be spent, whether on public schooling, building a new local library, or anything else the town may need.
Key Takeaways on Why We Pay Taxes
Seeing large sums of money taken out of your paycheck can be frustrating. However, knowing why we pay taxes to the government will help you understand where your money goes and who gets to decide. Being part of a democracy means you get to exercise your right to vote and make changes, including how and where your tax money is being spent. Overall, your tax money is helping you by providing you with smooth roads to drive on, schools for your children to attend, and national security to keep you and your family safe.
When tax season comes around, you can consult with tax preparation experts, such as those at Community Tax, who will help you complete an accurate tax return to get the most of your money. Whether it’s through tax credits and deductions or getting out of debt with the IRS, Community Tax is here to help.