Taxes play an important role in the functioning of modern society. Their primary goal is to fund government operations, but their role goes well beyond that. Policymakers use taxes as economic and social policy tools. Taxes also frequently reflect the underlying philosophies of policymakers. For this reason, issues involving taxes often affect large segments of the population and frequently cause controversy.
Federal revenues come from three major sources: individual income taxes, social insurance taxes, and corporate income taxes. Other sources include excise, estate, and gift taxes, customs duties, and other receipts.
State and local revenue systems vary widely by jurisdiction and generally use a different mix of taxes than the federal system. State and local governments tend to rely heavily on sales taxes and property taxes for funding rather than on income tax.
The tax systems at all levels of government are closely intertwined. First, states receive a considerable portion of their revenue from federal transfers. Second, the federal government subsidizes states indirectly through tax provisions benefitting states, such as by exempting state and local bonds from taxation. In addition, many state and local tax systems are administratively tied to the federal system, for example, by utilizing the income figure from federal tax forms as the starting point on state tax forms.
One common concept used in describing tax systems is their degree of progressivity. A tax is considered “progressive” if people with lower incomes pay a lower percentage of their income in tax than those with higher incomes. A “regressive” tax is the opposite: People with lower incomes pay a higher percentage of their income in tax than those with higher incomes.
The federal income tax is the largest progressive revenue source in the U.S. It is one of the key reasons why the overall public finance system, which includes all taxes and spending by all levels of governments, is progressive.
By comparison, the overall state and local tax structure is regressive. While, state and local income taxes are can be relatively progressive, sales, excise, and property taxes are all usually regressive.