U.S. Taxation System

Taxation comes in various forms and applied in different ways. Differences in taxable income and comprehensive income are referred to as tax preferences in the U.S. income tax code. Tax preference is justified on the grounds that it poses administrative difficulties on certain activities, that it improves equity, and that it encourages private expenditures that generate external benefits (Hyman, 2011). Income tax application depends on the size of the family and tax base is justified in terms of equity considerations. A family with many children may pay less tax than the family with the same income but fewer children. Due to the growing elderly population in the next twenty years, much has changed in how seniors are taxed by states (2008). Tax preferences for the elderly have resulted in growing competition between states to attract more seniors. The desire to lower taxes for the elderly is based on the desire to help a needy aging population who are confounded by skyrocketing medical bills, diminished work, unaffordable clothing, and relatively high food prices.

 The U.S. administrative system is different from the type of administrations seen in Western European countries in that, in the United Sates, states enjoy a degree of freedom in their ability to deliver economic policies that they deem attractive and beneficial to their state inhabitants (Klemm, 2009). Excess burden of tax preferences can lead to distortions in ways that lead to efficiency losses in markets (Hyman, 2011). There are various types of tax preferences in the U.S. income tax system. They include income in-kind and imputed housing rental income and miscellaneous exclusions and adjustments. It is difficult to measure income in-kind like do-it-yourself activities. Since there are no market transactions in houses occupied by owners and that they rent to themselves, they escape taxation. In fringe benefits, workers are excluded from taxation in salaries and wages. An employer contribution to an employee’s insurance is also excluded from gross income. A transfer by government to individuals is also excluded from gross income.

Looking at the phaseouts of deductions, exemptions, and credits and personal incomes of individual taxpayers, we see that those with the highest incomes paid between 35 and 36 percent of MTR in 2005 (Hyman, 2005). Education tax breaks instituted in the U.S. beginning 1990s, according to LaLumia (2012), tended to help the middle income. On the other hand, students from poor backgrounds benefited little from Pell Grants. Some states such as Alaska, Florida, and Washington, among others, depend on personal tax as a source of revenue (Hyman, 2011). States collect taxes in various forms with some applying flat-rate proportional structures while others limit state income taxation to interest income and dividends only. The problem with taxation is that it disrupts the financial stability of high wage earners who suffer increased taxation as their income rises.

Americans enjoy economic advantage over other countries because they work harder and put more hours to work. When Ronald Reagan was contesting the presidency in 1980, he promised to cut taxes. Reagan’s argument was based on the assumption that taxes were so high that people were discouraged from working harder (Mankiw, 2009). While some economics call for overall tax cuts, there is the belief that some taxpayers may be affected adversely and find themselves on the wrong side. I think it would be prudent to keep tax preferences the way they are at present.

Conway, K.S. & Rork, J.C. (2008). Income tax preferences for the elderly. Public Finance Review, 36 (5), 523-562. doi: 10.1177/1091142108316441

Hyman, D.N. (2011). Public finance: A contemporary application of theory to policy (10^th ed). Mason, OH: South-Western, Cengage Learning.

Klemm, D. (2009). Flexible local economic development - lessons from the United States. Local Economy, 24 (5), 426–432. doi: 10.1080/02690940903138194

LaLumia, S. (2012). Tax preferences for higher education and adult college enrollments. National Tax Journal, 65 (1), 59–90.

Mankiw, N.G. (2009). Principles of macroeconomics (5^th ed.). Mason, OH: South-Western, Cengage Learning.