Why Do We Pay Taxes?

What Your Federal, State and Local Taxes Buy You

why do we have to pay taxes
Why do we have to pay taxes? Ask Congress. Photo: Pamela Moore/Getty Images

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.

What Kinds of Taxes Are There?

Federal. The federal government will collect $3.6 trillion in taxes in FY 2016. Almost half (49 percent) comes from personal income taxes. Another third (31 percent) comes from payroll taxes, which is also a tax on income.

 Corporate taxes only pay 11 percent of the burden. The remaining 8 percent is excise taxes, tariffs, estate taxes, and earnings from the Federal Reserve's holdings.  For more, see Federal Government Tax Revenue.

State. States collected almost $1.7 trillion in 2013 (most recent available). Nearly one-third (31.3 percent) of state revenue comes from the federal government. Most of that is to pay 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. (Source: "The State of State Tax Policy," Tax Policy Center, 2013)

Local. This category includes cities, school districts, and counties. They collected almost $1.5 trillion in 2013.

They receive 32 percent of their revenue 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. (Source: "The State of Local Tax Policy," Tax Policy Center, 2013.)

How Does the Government Use 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 how our hard-earned money translates to government services. That's because the largest national expense is payments to seniors for Social Security. That's more than $900 billion. 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 nearly $775 billion. That includes support agencies like Homeland Security and the Veterans Administration.  It's hard to measure the benefit you receive from this. That's because it prevents attacks that subsequently didn't happen. It's also spent overseas in wars. For more, see U.S. Military Spending.

The third largest service is Medicare, at nearly $600 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 almost $400 billion. You only receive this if your income falls below a certain level. Even if you never need it, you benefit by keeping 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.

Roughly $225 billion goes toward interest on the national debt. That's because Congress routinely overspends. 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. For more, see Deficit Spending.

All other welfare and government retirement programs total $600 billion combined. All other government agencies, like Education ($70 billion), Energy ($30 billion,) and NASA ($18 billion) total $450 billion. For more, see Where Do Your Federal Tax Dollars Go?

State.  The largest state expenditure ($500 billion) is 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) is for employee retirement and other benefits. States spend $284 billion on education, $116 billion on transportation, and $114 billion on health and hospitals. In total, states spend $1.5 trillion each year. (Source: Author's analysis of "2014 State and Local Government Survey Data," U.S. Census.)

Local. The largest local expenditure ($631 billion) is for education and libraries. Water and sewer services cost $212 billion. Admin is next, at $184 billion. Only $46 billion of this goes toward retirement, but many cities are underfunded. Detroit, Michigan, and Stockton, California declared bankruptcy in part because of underfunded pensions. They defaulted on their municipal bonds so they could protect pensions and improve other services. Local government pays $164 billion on police and fire services, $145 billion on transportation, and $141 billion on health and hospitals. Welfare and public housing costs $93 billion, and parks cost $41 billion. In total, local governments spend $1.6  trillion annually. (Source: Author's analysis of "2014 State and Local Government Survey Data," U.S. Census.)

Who Decides?

Federal. Either the President or a member of Congress can suggest a tax. Most taxes have started in the White House. The President will normally 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.

Taxes start 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. It 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. (Source: "Writing and Enacting Tax Legislation," U.S. Department of the Treasury.)

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. (Source: "Tax Policy Handbook for State Legislatures," National Conference of State Legislatures, February 2010.)

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

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