Why Do We Pay Taxes?

What Your Federal, State and Local Taxes Buy You

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We pay taxes because the federal, state, and municipal governments enact tax laws. That tax revenue pays for government services. The federal government collects about the same as the state and local governments combined.

Kinds of Taxes

Federal. The federal government tax revenue will be $3.6 trillion in FY 2018. Half comes from personal income taxes. A third (33 percent) comes from payroll taxes, which is also a tax on income. Corporate taxes only pay 10 percent of the burden. The remaining 7 percent is excise taxes, tariffs, estate taxes, and earnings from the Federal Reserve's holdings. 

State. States collected almost $1.6 trillion in 2015 (most recent available). Another one-third (31.3 percent) of state revenue comes from the federal government. That pays for the Medicaid health care program for low-income families. Sales taxes contribute 23.4 percent. Payments to state universities, public hospitals, and toll roads add another 18.5 percent. Income taxes provide 18.4 percent. State license fees, estate taxes and severance taxes furnish 5.98 percent. The remaining 2.7 percent is from corporate income taxes.

Local. This category includes cities, school districts, and counties. They collected $627 billion in 2015. Another 32 percent of their revenue comes from state governments, mostly for aid for school districts. Four percent comes directly from the federal government for low-income housing. Property taxes contribute 29.7 percent. Fees for water, sewage, and parking meters add 22.8 percent. Sale taxes furnish 2.9 percent. Some cities charge stadium and business license fees, supplying 2.3 percent to the total local revenue base.

Other cities also charge income taxes, providing 1.9 percent to the total. 

How the Government Uses Taxes

Federal. The Constitution gives Congress the "the power to lay and collect taxes."  But when Tax Day comes along each April, we feel that much of our income goes into a black hole called the IRS. We don't see where our federal tax dollars go. That's because the largest national expense is payments to seniors for Social Security. That's more than $1 trillion. But that comes from our payroll taxes and investments by the Social Security Trust Fund. Think of these taxes as saving for your future. 

The next largest service is defense at $824.7 billion. That includes support agencies like Homeland Security and the Veterans Administration. It's hard to measure the benefit you receive from this because you don't see it. Military spending prevents attacks that subsequently didn't happen. It's also spent overseas in wars. 

The third largest service is Medicare at $582 billion. Payroll taxes only cover 60 percent of these expenses. Like Social Security, your are paying for services you'll receive after you turn 65.

Medicaid is the fourth largest service at $404 billion. You only receive this if your income falls below a certain level. Even if you never need it, you benefit by helping low-income children and their families receive preventive care. Without it, they use the expensive hospital emergency room as a primary care physician. You ultimately pay for that through higher hospital and insurance fees. Studies have also shown that medical care is critical to allow children to become productive members of society.

The interest on the national debt is $315 billion. Congress routinely follows deficit spending. Your state and local governments must follow balanced budget laws, otherwise they'd overspend too. The federal budget deficit gets added to the debt each year. It isn't really a service. On the other hand, it allows us to receive services now that we don't have to pay for until the future. 

Other welfare and government retirement programs total $544 billion. All other government agencies total $419 billion. These include Health and Human Services ($65.7 billion),  Education ($59 billion), and NASA ($19.1 billion.) 

State.  In 2014, the largest state expenditure ($500 billion) was for social services, including Medicaid, welfare, and public housing. That's because states administer federal funds for these programs. It makes sense that the next largest category is administration ($377 billion). Most of this ($278 billion) was for employee retirement and other benefits. States spent $284 billion on education, $116 billion on transportation, and $114 billion on health and hospitals. In total, states spend $1.5 trillion each year.


Local. The largest local expenditure ($631 billion) was for education and libraries. Water and sewer services cost $212 billion. Administration was next, at $184 billion. Only $46 billion of this went toward retirement, but many cities are underfunded. Detroit, Michigan, and Stockton, California declared bankruptcy in part because of underfunded pension funds. They defaulted on their municipal bonds so they could protect pensions and improve other services. Local government paid $164 billion on police and fire services, $145 billion on transportation, and $141 billion on health and hospitals.

Welfare and public housing cost $93 billion, and parks cost $41 billion. In total, local governments spent $1.6  trillion annually. 

Who Decides

Federal. Either the president or a member of Congress can suggest a tax. Most taxes begin in the White House. The president will mention it in the State of the Union Address. It will also be in the budget. The Treasury Department drafts the legislation. The president then submits it to Congress.

The tax bill starts in the U.S. House of Representatives. The House Ways and Means Committee must approve it first. The Committee reviews the new law. It calls in experts to weight the pros and cons. Industry leaders discuss how it will affect their businesses. The committee asks the Treasury Secretary to explain the details. It even gives the public a chance to weigh in. The Committee then votes on the new tax. It drafts the legislation that's submitted to the House. 

Once the House approves it, the bill goes to the U.S. Senate Finance Committee. It holds its own hearings. It then writes its own legislation that it submits to the full Senate. If the Senate agrees with the House bill, it sends it to the president for signature.

More often, the Senate comes up with its own version. That's because the House and the Senate have their own agendas. The Senate sends its version back to the House. If the House disagrees, it forms a Conference Committee to iron out the differences. That final version is sent to the president for signature. By then, it may have become a completely different bill. 

Therefore, the entire process is one giant negotiation between elected officials from different states and parties. Various industry lobbyists are also influential. Special and general interest groups also weigh in. 

State. Each State's legislature decides what kinds of taxes to impose. They also approve rate increases. They must determine if the taxes will be enough to pay for spending. They must also compare their tax structure to those of competing states. 

Local. Most taxing authorities have elected representatives, such as city councils, boards, or commissions. They decide the types of taxes for their jurisdiction.