The Tax Base, or What Do We Tax?
The first article of the constitution gave Congress the power to raise taxes. In 1913, the 16th Amendment gave Congress the further power to charge an income tax. Ever since that amendment, Congress has increasingly focused on raising their revenue from incomes (or sources), but Congress also raises revenue from the uses of our wealth.
Revenue Raised From Sources
The basic idea of the Income Tax is that it assesses a tax on income, which is the total gain of wealth in a given year. Our income consists of our wages, interest from investments, increase in property values, inheritances, and other things; it is anything that increases our wealth. The Income Tax has been as high as 90% for the highest earners over the last century and today is 37% for the highest earners. However, there are three important exceptions to taxable income; unrealized gains, capital gains, and inheritance.
Congress is not allowed to assess a tax on unrealized gains, which are the increases in value of assets that we have not sold. This makes sense; if my house increases in value, I have increased my wealth even though I may not have enough money to pay for a corresponding increase in taxes for two reasons; first, I do not have any more money on hand than before and, second, my house could lose value the next year. I could be charged taxes I can’t afford on wealth that I never actually get (that is what makes this unrealized; I don’t have it yet). This requirement makes the income tax messy, however, because it means that people who already have assets can gain wealth in ways that the government is not taxing.
Once those appreciated assets are sold, their increase in wealth is called capital gains (kinda tautological; capital = wealth, gains = gains). Congress wanted to encourage people to save their money instead of spend it, so naturally they lowered the tax rate on capital gains. While people can pay up to 37% for their income, the tax on their capital gains is topped at 13%. Taking these two exceptions together, an increase in wealth that comes from something that appreciates in value that is eventually sold is not taxed at all during the period that it is increasing in value and taxed at a significantly lower rate than other income once it finally is sold (which may be after it is inherited by someone else).
Another significant exception is made for inheritances. If the net wealth of the decedent exceeds $22,000,000, a 40% “death tax” is (technically) imposed on the net wealth of the decedent, but this was never levied against the recipient of the inheritance, for reasons similar to above. If I inherit a house, I did gain wealth but I don’t have any more cash on hand to pay an increase in taxes for it, so forcing me to do so might make my inheritance more of a financial curse than a gift. Further, this tax can easily be avoided by the decedent through a dynasty trust, so it doesn’t really exist for anyone (the details are unimportant, but it is obscenely easy to make a dynasty trust if you have $22 million).
Exceptions for unrealized gains, capital gains, and inheritances were created to encourage saving in the middle class. These exceptions made it easier to save for retirement and encouraged the saver to pass their money along to their children at the end of their life, discouraging wasteful behavior. However, taken together, they have given the upper class three perfect tools. Wealth can be stored in appreciating assets, like property or mutual funds, which are passed along to children, who can live off of the interest and only ever pay very low tax rates.
Revenue Raised from Uses
The Government also raises spending taxes, which are taxes paid when money is spent. These taxes are an insignificant source of the government’s revenue compared to income tax, which means that most of the revenue raised by the government does not happen when the wealth itself is used. The things that are taxed are things like gas and cigarettes, which tend to raise revenue for things related to their use, like roads and health care.
The government needs money to operate. That money comes from taxes and taxes have to come from someone. This means that if one person isn’t paying as much in taxes then another person is paying more in taxes. If low spending taxes bring in less money for the state, for example, then income taxes must be higher to compensate. Even if the money comes from debt spending, then it is coming from future taxpayers, who are paying it with interest.
This is often used to encourage behavior beneficial to society; high taxes on cigarettes cover part of the increased cost of health care incurred by smokers while deterring the practice of smoking. Low taxes on savings encourage people to save money while they have an income; it is more efficient for them and prepares them for their retirement when they will no longer have an income to rely on.
But this feature of our tax system also creates opportunities for loopholes. Most of America’s tax revenue comes from taxes on sources of income, but taxing income only works if all income is taxed; exceptions for sources like asset appreciation or inheritances push the tax burden off of those who rely on inheritance and onto those people who rely on wages for their income. Failing to tax all income is a failure to effectively tax wealth, because wealthy people will concentrate their assets where they won’t be taxed; it saves them billions of dollars that are paid for by everyone else.