Taxation and Public Finance

Taxation is the primary mechanism by which the federal government raises the revenue necessary to fund public services, national defense, infrastructure, and the social programs that collectively define the scope of American governance. The constitutional authority to tax is among the first powers enumerated in the Constitution — Article I, Section 8 grants Congress the power to "lay and collect Taxes, Duties, Imposts and Excises." The Sixteenth Amendment, ratified in 1913, specifically authorized the federal income tax, removing constitutional constraints that had prevented earlier income tax legislation. This page covers the structure of the federal tax system, the Internal Revenue Service, the major categories of federal taxation, tax-exempt organizations, and the federal budget process through which tax revenues are allocated to public purposes.

The Internal Revenue Service

The IRS is a bureau of the Department of the Treasury responsible for administering and enforcing the Internal Revenue Code (Title 26 of the United States Code). The IRS collects approximately $4.7 trillion in gross tax revenue annually and processes over 150 million individual income tax returns. It employs approximately 90,000 workers (a figure that is increasing under the Inflation Reduction Act's allocation of $80 billion over ten years for IRS modernization, enforcement, and taxpayer services).

The IRS performs four primary functions:

• Taxpayer services — Providing forms, instructions, publications, and direct assistance to help taxpayers understand and comply with their tax obligations. The IRS maintains a website (irs.gov), a toll-free phone line, and Taxpayer Assistance Centers in most metropolitan areas.
• Return processing — Receiving, processing, and verifying tax returns filed electronically and by mail. The IRS processes approximately 250 million tax returns annually across all categories (individual, business, employment, excise, and exempt organization returns).
• Enforcement — Auditing returns, investigating tax fraud, and collecting unpaid taxes. The IRS audit rate for individual returns has declined to below 0.5% in recent years, though audit rates are higher for certain categories (high-income individuals, large corporations, and returns claiming the Earned Income Tax Credit).
• Tax-exempt organization oversight — Reviewing applications for tax-exempt status, monitoring compliance with exemption requirements, and revoking exemptions for non-compliant organizations.

The Taxpayer Bill of Rights, codified at 26 U.S.C. § 7803(a)(3), establishes ten fundamental rights for taxpayers in their dealings with the IRS, including the right to be informed, the right to quality service, the right to pay no more than the correct amount of tax, the right to challenge the IRS's position and be heard, the right to appeal, and the right to privacy and confidentiality.

Individual Income Tax

The individual income tax is the single largest source of federal revenue, accounting for approximately 49% of total federal receipts in fiscal year 2023. The tax applies to taxable income — gross income minus allowable deductions and exemptions.

Gross income, as defined by 26 U.S.C. § 61, includes "all income from whatever source derived" — wages, salaries, tips, interest, dividends, capital gains, business income, rents, royalties, pensions, and other categories. Certain types of income are specifically excluded, including interest on state and municipal bonds, certain employer-provided benefits, and gifts and inheritances (which are subject to separate gift and estate tax rules).

The federal income tax uses a progressive rate structure with seven tax brackets for 2024:

The progressive structure means that each rate applies only to income within that bracket — a single filer earning $60,000 pays 10% on the first $11,600, 12% on income from $11,601 to $47,150, and 22% on income from $47,151 to $60,000. The effective tax rate (total tax divided by total income) is always lower than the marginal rate.

Taxpayers reduce their taxable income through either the standard deduction ($14,600 for single filers, $29,200 for married filing jointly in 2024) or by itemizing deductions (mortgage interest, state and local taxes up to $10,000, charitable contributions, and certain other expenses). Tax credits reduce the tax owed dollar-for-dollar; major credits include the Child Tax Credit ($2,000 per qualifying child), the Earned Income Tax Credit (up to $7,430 for families with three or more qualifying children in 2024), and education credits.

Employment and Payroll Taxes

Payroll taxes are the second largest source of federal revenue, accounting for approximately 36% of total federal receipts. These taxes fund Social Security and Medicare:

• Social Security (OASDI) tax — 6.2% on wages up to the taxable maximum ($168,600 in 2024), paid by both the employee and the employer (12.4% combined)
• Medicare (HI) tax — 1.45% on all wages, paid by both the employee and the employer (2.9% combined), with an additional 0.9% surtax on employee wages exceeding $200,000 ($250,000 for married couples filing jointly)
• Federal Unemployment Tax (FUTA) — 6.0% on the first $7,000 of wages per employee, paid by the employer only, with a credit of up to 5.4% for contributions to state unemployment programs

Self-employed individuals pay both the employer and employee shares of Social Security and Medicare taxes under the Self-Employment Contributions Act (SECA), totaling 15.3% on net self-employment income. They may deduct the employer-equivalent portion when calculating their adjusted gross income.

Corporate Income Tax

The corporate income tax applies to the taxable income of C corporations. The Tax Cuts and Jobs Act of 2017 reduced the corporate tax rate from a graduated structure with a top rate of 35% to a flat rate of 21%, effective for tax years beginning after December 31, 2017. Corporate income tax revenue accounted for approximately 10% of total federal receipts in fiscal year 2023.

Pass-through entities — S corporations, partnerships, and limited liability companies (LLCs) treated as partnerships for tax purposes — do not pay entity-level federal income tax. Instead, income and losses pass through to the owners' individual tax returns. The Tax Cuts and Jobs Act created a 20% deduction for qualified business income from pass-through entities under Section 199A, subject to income limitations and phase-outs for specified service trades or businesses.

The corporate tax system includes provisions addressing international taxation. The global intangible low-taxed income (GILTI) regime, enacted in 2017, imposes a minimum tax on the foreign earnings of U.S. multinational corporations. The Inflation Reduction Act of 2022 introduced a 15% corporate alternative minimum tax (CAMT) on the adjusted financial statement income (book income) of corporations with average annual financial statement income exceeding $1 billion.

Other Federal Taxes

Estate and gift taxes — The federal estate tax applies to the transfer of assets at death, with an exemption of $13.61 million per individual in 2024 (scheduled to revert to approximately $7 million, adjusted for inflation, after 2025 when the Tax Cuts and Jobs Act provision sunsets). Assets above the exemption are taxed at a flat rate of 40%. The gift tax, imposed on lifetime transfers, shares the same exemption threshold and rate to prevent avoidance of the estate tax through lifetime gifting.

Excise taxes — Federal excise taxes are levied on specific goods, services, and activities including motor fuels (18.4 cents per gallon for gasoline), tobacco products, alcoholic beverages, air transportation, and certain chemicals. Excise tax revenue funds dedicated trust funds — the Highway Trust Fund is financed primarily by fuel taxes, and the Airport and Airway Trust Fund is financed by aviation excise taxes.

Capital gains taxes — Long-term capital gains (on assets held more than one year) are taxed at preferential rates of 0%, 15%, or 20%, depending on the taxpayer's income level. Short-term capital gains are taxed as ordinary income. The net investment income tax (NIIT) imposes an additional 3.8% tax on investment income for individuals with modified adjusted gross income exceeding $200,000 ($250,000 for married filing jointly).

Tax-Exempt Organizations

The Internal Revenue Code provides tax-exempt status to organizations that meet specific requirements under Section 501(c). The most significant categories include:

• 501(c)(3) — Charitable, religious, educational, scientific, and literary organizations. Contributions to 501(c)(3) organizations are tax-deductible for donors. These organizations are prohibited from participating in political campaigns and may engage in lobbying only to an insubstantial degree (or elect the Section 501(h) expenditure test, which allows lobbying expenditures up to defined limits).
• 501(c)(4) — Social welfare organizations, including civic leagues. These organizations may engage in unlimited lobbying and some political activity (which must not be their primary activity). Contributions are not tax-deductible for donors, and the organizations are not required to publicly disclose their donors.
• 501(c)(6) — Business leagues, chambers of commerce, and trade associations. Dues payments may be partially deductible as business expenses, but the portion allocable to lobbying is not deductible.

The IRS oversees approximately 1.9 million tax-exempt organizations. Organizations with gross receipts above $50,000 must file annual information returns (Form 990, 990-EZ, or 990-PF), which are publicly available and provide financial and operational data including revenue, expenses, executive compensation, and program activities.

The Federal Budget Process

The federal budget process determines how tax revenues and borrowed funds are allocated among competing governmental priorities. The process involves both the executive and legislative branches and follows a statutory framework established primarily by the Congressional Budget and Impoundment Control Act of 1974.

Presidential budget request — The President submits a detailed budget proposal to Congress by the first Monday in February for the upcoming fiscal year (which runs from October 1 to September 30). The budget is prepared by the Office of Management and Budget (OMB) based on agency requests and presidential priorities. The presidential budget is a proposal — Congress is not bound by it.

Congressional budget resolution — The House and Senate Budget Committees each draft a concurrent budget resolution setting overall spending and revenue targets. The budget resolution establishes spending limits (called 302(a) allocations) for each appropriations subcommittee and may include reconciliation instructions directing committees to achieve specified changes in spending or revenue.

Appropriations — Congress funds the discretionary portion of the federal budget through 12 annual appropriations bills (covering defense, education, housing, transportation, justice, and other functions). If appropriations bills are not enacted by October 1, Congress passes continuing resolutions to fund the government at existing levels. If neither an appropriation nor a continuing resolution is in effect, a government shutdown occurs — non-essential federal operations cease until funding is restored.

Mandatory spending — Programs such as Social Security, Medicare, Medicaid, and interest on the national debt operate under permanent statutory authority and do not require annual appropriation. Mandatory spending is modified through changes to the authorizing statutes, typically through the reconciliation process, which allows budget-related legislation to pass the Senate with a simple majority (bypassing the filibuster's 60-vote threshold).

In fiscal year 2023, total federal spending was approximately $6.1 trillion, with revenues of approximately $4.4 trillion, producing a deficit of approximately $1.7 trillion. The national debt — the cumulative total of past deficits — exceeds $34 trillion. Interest payments on the debt have grown to become one of the largest categories of federal spending, exceeding $650 billion in fiscal year 2023.

State and Local Taxation

State and local governments levy their own taxes independently of the federal system, creating a layered tax structure that varies significantly by jurisdiction:

• State income taxes — 43 states and D.C. levy individual income taxes, with rates ranging from flat rates of approximately 3% to progressive rates reaching 13.3% (California). Seven states impose no individual income tax: Alaska, Florida, Nevada, New Hampshire (which taxes only interest and dividends, being phased out by 2027), South Dakota, Tennessee, Texas, Washington, and Wyoming.
• State sales taxes — 45 states and D.C. levy general sales taxes, with rates ranging from 2.9% (Colorado) to 7.25% (California). Local sales taxes can increase the combined rate further — the highest combined state and local rate exceeds 11% in some jurisdictions. Five states have no general sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon.
• Property taxes — Levied primarily by local governments (counties, municipalities, and school districts), property taxes are the largest source of local government revenue. Rates vary dramatically by jurisdiction, ranging from effective rates below 0.5% to rates exceeding 2% of assessed property value.

The interaction between federal and state tax systems creates significant complexity. The federal Tax Cuts and Jobs Act's $10,000 cap on the state and local tax (SALT) deduction — which limits the amount of state and local income, sales, and property taxes that can be deducted on federal returns — has had particular impact on taxpayers in high-tax states.