Federal Income Tax: What is it? and Why do we need it?
February 3, 1913. While innocuous on it’s face, on February 3, 1913 the way we as Americans live our lives changed. It was on this date the 16th amendment was ratified, permitting Congress to levy an income tax on Americans. So began our complex relationship with income taxes.
While April 15th, tax day, is etched into our collective memory, taxes have been a part of American culture since the founding of the country. In fact, taxes were the catalyst for the creation of the country. Remember “No taxation without representation?” Tax, however, as we understand it today includes a complex system of different types of levies on taxpayers: sales tax, property tax, excise taxes, and income tax, among others. Of the variety of different types of taxes that exist today, in the United States, income account for over 48% of all revenue generated by the Federal Government.
At its core, the formula to tax income boils down to a simple formula known as the “Haig-Simons Equation.” Developed by two economists in the 1920s and 1930s, the Haig-Simons Equation states succinctly: Income is equal to the change in net worth plus consumption. Where consumption is money that is spent on goods and services of any kind and change in net worth is the increase or decrease in a taxpayer’s total wealth. At its core, the formula states that a system of taxation should focus on these two elements, consumption and change in net worth. In the United States, we adopted a form of the Haig-Simons equation, mainly a subset of the change in net-worth portion of the equation. In sum, a Federal Income Tax is: a tax on the change in one’s net worth realized meaning the taxpayer actually receives the income being generated, i.e the receipt of cash following the sale of stock, or the receipt of cash of an account payable.
Once a basic understand of Federal Income Tax is established, the second pressing question is why do we need taxation. While a more in-depth analysis would show that the answer to such a simple question warrants a multi-factored answer, distilled into a word the reason we need tax is fairness. A progressive income tax compared to other forms of taxation, property tax, excise taxes, consumption taxes, etc. is the the agreed upon method to apply a tax on citizens in the most fair, simple, equal way possible. Put differently, the general consensus surrounding tax policy is the fairest tax system is one based on a taxpayer’s “ability to pay.” Thus, a taxpayer who generates more income, has a greater ability to pay and therefor their tax should be greater. An ability to pay is based on the utility of generating an additional dollar of income, which simply means that a the value of a dollar to a person who only has $1 is greater than the value of an additional dollar to a person who has $100. So, as the logic follows, the person with $100 values each dollar less and as such has a greater ability to pay.
But again, to answer the question at the center, why do we need an income tax, the answer should be straightforward, an income tax generates the greatest amount of revenue in the fairest way possible. Taxes help fund our day to day lives from emergency services, to ensuring that our government from the President’s staff all the way to the Department of Natural Resource Park Ranger is paid to provide the services and public goods that we enjoy on a day to day basis.
Comment Policy: While I have limited experience as a practitioner and as an attorney, I believe that my work will be better when this blog generates input from others. Involvement from others makes the site better. That is why I am choosing to keep the site open to comments.If you want to make a public comment, you must identify yourself (using your first and last name) and register by including your email. If you do not, I will remove your comment. In a comment, if you disagree with or intend to criticize someone (such as the poster, another commented, a party or counsel in a case), you must do so in a respectful manner. I reserve the right to delete comments. If your comment is obnoxious, mean-spirited or violates the sense of decency I will remove the comment. While you have the right to say what you want, you do not have the right to say what you want on our blog.
h/t to Proceedurally Taxing for their insightful Comment Policy of which I am adopting.
