Sales Tax vs. Income Tax: Overview
Sales tax and income tax are two primary methods by which governments generate revenue, each with distinct implications for taxpayers and the economy. Sales tax is levied on transactions, typically as a percentage of the sale price, and is mainly collected by state and local governments. It varies depending on the type of goods sold, with certain items, like food and medications, often exempt or taxed at lower rates. Conversely, income tax is based on the earnings of individuals and is collected by both state and federal governments, usually allowing for certain deductions. Proponents of income tax argue that it is more equitable, taxing individuals based on their ability to pay, whereas advocates for a sales tax contend that it simplifies tax collection and could potentially reduce the burden on income earners. The ongoing debate around these taxation forms often centers on issues of fairness, economic behavior, and the need for government services, especially during economic downturns when budget shortfalls become a pressing concern. Additionally, the rise of internet sales has complicated the discussion, leading to calls for national policies to address tax collection for online transactions. Understanding these differing perspectives can provide insight into broader discussions about taxation and economic equity in society.
Sales Tax vs. Income Tax: Overview
Introduction
Taxes on personal income and taxes on sales transactions are two of the biggest sources of revenue for governments. However, taxes have long had multiple goals beyond simply paying for government services. Among these have been the social ideals of relieving poverty and avoiding an excessive imbalance between rich and poor. On the other hand, some politicians believe taxes should be limited to paying for government operations. In the thick of this larger philosophical and political debate come arguments over whether taxes on personal incomes (collected by both states and the federal government) should be replaced by taxes on sales (currently collected only by state and local governments, but not by the federal government). This discussion fits into the larger historical debate over the fairness and efficacy of different types of taxes.
In a troubling economy, this discussion takes on greater relevance. Government entities don't often sell anything, so the best way to raise money is to tax the populace or cut costs through layoffs and budget cuts. Typically, tough economic conditions also create a rise in the need for services such as food and energy assistance and unemployment. Increases in taxes can avoid decreases in service. However, few citizens want to pay more of any kind of tax. In early 2009, California was facing a $42 million budget shortfall for fiscal years 2009 and 2010. The state was considering delaying tax refunds and other payments. Arizona was ranked high among states with the largest budget shortfall at 12 percent for fiscal year 2009, which translated into $1.6 billion. Already, the combined projected budget deficits of states were nearly double the shortfalls during the recession between 2002 and 2005. States in trouble began to look to the federal government, which faced its own budget deficit.
Understanding the Discussion
Excise tax: Fees paid for engaging in particular activities. Examples include licenses, like building permits, or a tax on certain goods, such as tobacco. An excise tax is levied on a good or activity, rather than on a transaction.
Flat tax: A form of income tax in which everyone pays the same percentage of their income as taxes; this differs from the current system in which a higher percentage is paid on incomes above certain levels. For example, people might pay 10 percent on the first $30,000 they earn, 15 percent on the income between $30,001 and $100,000, and 25 percent on income over $100,000. Under a flat tax system, everyone would pay the same percentage on all income.
Income tax: Taxes on money earned. This tax is paid on all forms of income (work, interest on a bank account, profits from the sale of stocks), although income tax laws typically allow people to deduct from their income certain expenses, such as paying for a home mortgage. For example, someone earning $50,000 per year who pays $15,000 per year for a mortgage will only pay taxes on $35,000.
Internal Revenue Service (IRS): The federal agency responsible for collecting individual income taxes. It is controversial on a number of grounds: it is thought to use harsh methods to collect taxes, and to have extraordinary power to look into citizens' private affairs to determine whether income was earned that ought to be taxed.
Property tax: Usually paid to local governments as a means of financing education. Property tax is calculated as a percentage of the value of a property (meaning land and buildings on it).
Sales tax: A tax levied on a transaction, typically stated in terms of a percentage of the sale (e.g. 5 percent of the value of the sale is added to the transaction as a "sales tax"). Sales taxes sometimes depend on what is being sold (as an excise tax might in the case of cigarettes, for example), although in some cases the sale of certain items, such as food, may not incur a sales tax. Other items such as prescriptions may be taxed at a lower rate or at a higher rate, such as cigarettes, liquor, and other "sin" taxes.
Tariffs (customs duties): Fees collected by the federal government for importing goods. The tariff, or tax, on imports varies according to the type of good. Tariffs are both a source of income and a means of helping domestic manufacturers by canceling out the price advantage of low-cost exporters on certain goods. "Free trade" is an expression referring to tariff-free international trade in which American manufacturers compete with foreign firms.
History
On one level, taxes are collected by governments in order to pay for services provided, such as national defense, paving highways, or public schools. In the mid-twentieth century, economists realized that taxes could affect peoples' behavior. A high tax on alcohol or tobacco, for example, might make harmful products more expensive and thus discourage some people from buying them. Some income taxes might discourage people from working harder since every extra dollar they earned might result in a significant percentage going to the government, whereas lower income taxes might encourage people to spend money for consumer goods and thereby stimulate greater economic activity. From a political-philosophical viewpoint, those opposed to the role of government in people's lives have often advocated cutting taxes as a means of "starving" government institutions, whereas people who believe government can be effective in improving conditions for everyone sometimes advocate higher taxes to pay for such improvements.
Arguments over taxation typically focus on two areas: the amount of tax collected and the basis on which taxes are paid. In the latter case, arguments often revolve around the impact of taxes, how taxes impact people of varying incomes, and how they might influence a change in people's behavior.
In most instances, both federal and state governments tax incomes. They also collect excise taxes, typically a flat fee for a government permit or license, or on a particular type of good (alcohol and tobacco, for example). Only states and some county or city governments levy sales taxes. Both the federal and state governments try to calculate the impact of taxes on their economies.
In pre-revolutionary America, citizens seldom paid taxes directly; mostly taxes were collected on imports (tariffs, also known as customs duties), with some excise taxes. According to British tradition, "customs" paid on imports belonged to the king (the central government) and did not require parliamentary approval. But when the British government imposed other taxes, including a "stamp tax" and a tax on tea, colonists, being loyal Englishmen at the time, strongly objected to not having a voice in Parliament. "No taxation without representation" became a rallying cry for the American Revolution, and also presaged a longstanding debate over paying taxes to the central government.
When the Constitution was adopted in 1789, the federal government was given specific power to collect taxes to pay off the debts of the states and provide for the military. From the late 1790s, the federal government periodically levied "direct taxes" (taxes paid by individuals rather than by merchants or state governments) to pay for the extraordinary costs of waging war. In 1861, the federal government extended customary excise taxes to include a tax on individuals' personal income called the Revenue Act of 1861. This tax was abolished in 1872. From 1868 until 1913, revenue was derived from taxes on goods. The largest portion of taxes came from alcohol and tobacco.
An effort to restore a federal income tax in 1894 was challenged on the grounds that the Constitution allowed the federal government to impose direct taxes only if they were levied in proportion to each state's population. The Supreme Court declared personal income taxes unconstitutional in 1895, leading to passage and ratification of the Sixteenth Amendment in 1916, specifically permitting personal federal income taxes. In general, agricultural areas in the South and West favored the income tax in order to avoid a federal tax on property. The government felt the pressure during this time to impose taxes to pay for expenses and war activities. Meanwhile, citizens balked at the imposition of income taxes, since any taxes were seen as unfair to people with lower incomes.
Sales Tax vs. Income Tax Today
The argument over taxation's role in avoiding an imbalance between rich and poor lies at the heart of the contemporary debate over whether income taxes should be replaced by sales taxes, at both the federal and state levels. Income tax advocates argue that people should be taxed based, at least in part, on their ability to pay. After allowing a certain amount of tax-free income needed to survive, income taxes tend to extract more money from the rich than from the middle-class or the poor. Opponents of income taxes argue that this discourages people from earning more money. Income tax supporters also suggest that the current tax system is outdated and that income tax will circumvent lost revenue due to increasing internet sales where taxes are not paid. Sales tax advocates argue that a percentage of each transaction should be collected by merchants to finance the federal government. This would eliminate the complicated collection system represented by the Internal Revenue Service (IRS). Sales-tax-only advocates say that provisions can be made to protect the poor, such as a rebate to those with poverty-level incomes. They also state that collections would be cheaper and easier (because it would be much harder to avoid taxes paid on every purchase), and that the rich would pay higher taxes based on their greater number of purchases.
Internet technology has added another twist to the tax debate. In most states, merchants selling goods to consumers in other states (via the internet, for example) do not collect state sales taxes. Technically, these taxes are still due from the buyers, but this requirement is largely ignored. Some see the continued growth of online sales at the expense of local retailers as an argument for a national sales tax on internet transactions.
In March 2011, Illinois governor Pat Quinn signed legislation into law that requires large internet-based retailers to pay a 6.25 percent sales tax. The measure was opposed by large retailers such as Amazon but was supported by the state's brick-and-mortar retailers. In October 2013, however, the Illinois Supreme Court vacated the law, ruling that its provisions would violate the Internet Tax Freedom Act of 2000.
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