Taxes are more than just numbers. They shape our economy, influence behavior, and affect every American’s financial decisions. In 2024, Americans contributed $2.5 trillion in income taxes and $1.2 trillion in Social Security taxes to fund services like Social Security and infrastructure. Yet, the tax code faces mounting criticism for its complexity, perceived inequities, and impact on economic growth at both the state and national levels.

Tax policy is a complex and contentious issue, shaped by competing priorities such as fairness, economic growth, and simplicity. At both the state and federal levels, policymakers face challenges like revenue volatility, tax avoidance, and balancing income and consumption taxes. As the U.S. grapples with these issues, reforms must create a system that fosters competitiveness, encourages investment, and ensures sustainable funding for public services—all while minimizing distortions in economic behavior.

Taxpayers have the power to demand smarter, fairer tax policies that promote economic growth. By staying informed and engaging in discussions about tax reform, citizens can advocate for changes that simplify the tax code, close loopholes, and reduce unnecessary burdens. Active participation in the democratic process ensures that tax policy reflects the priorities of the people it serves.

KEY TERMS

• Progressive Tax: As income increases, it is taxed at a higher rate. The system is based on income ranges, or brackets. This is how the U.S. tax code operates and applies to individual and corporate taxes.
• Marginal Tax Rate: The percentage of the next dollar earned that goes to the government. This differs from the average tax rate (the percentage of total income that goes to the government).
• Tax Credits: Reduces the amount of tax owed, versus income that is taxable. The most well-known tax credits are the Earned Income Tax Credit and the Child Tax Credit program.
• Individual Taxes: Levied upon individual taxpayers through a variety of mechanisms, including payroll and income taxes. These have a direct effect on economic growth.
• Flat Tax: A set rate that all taxpayers are subject to, regardless of any other factors.
• Property Tax: Annual tax based on the value of the property in its current state. Local governments assess and collect these and they are often used to pay for community resources. Investigate how your property taxes compare to other localities.
• Consumption Tax: Wide, general tax on a good or service. The U.S. government used them before replacing them with the income tax.
• Excise Tax: A type of consumption tax, sometimes called a “sin tax.” They apply to a specific class of goods, such as alcohol, tobacco, or gasoline, often to change consumption patterns and collect revenues.
• Payroll Tax: Also known as FICA, this tax is technically divided between the employer and employee, but the employee bears the full weight through lower wages.
• Tax Deductions: Expenses a taxpayer can subtract from their income, thus lowering the amount they owe. Standard deductions are automatically not subject to tax. Itemized deductions include all tax-deductible expenses.

MORE RESOURCES

Khan Academy breaks down progressive tax brackets (4 min).

PragerU takes a closer look at progressive and flat tax systems (5 min).

PragerU covers taxation on small businesses (3 min).

HISTORY

Taxes have played a significant role in U.S. history, dating back to the country’s inception. ‘Taxation without representation’ was a rallying cry for independence from British rule, fueled by taxes like the Stamp Act of 1765 and the Tea Act of 1773. After independence, Congress relied primarily on tariffs and excise taxes until the Civil War necessitated the first federal income tax in 1861, but they repealed it in 1872.

Congressional attempts to establish a federal income tax in the late 1800s and early 1900s were overturned by the Supreme Court. In 1913, the 16th Amendment was ratified, allowing Congress to levy income taxes without apportionment among states. That same year, Congress passed the Underwood-Simmons Tariff Act (Revenue Act), which introduced progressive income taxes and lowered tariffs.

Congress established the Department of the Treasury in 1789. The Bureau of Internal Revenue was established in 1862 during the Civil War and was reorganized as the Internal Revenue Service in 1953.

DID YOU KNOW?

During World War I, income taxes expanded under the Revenue Act of 1918 to support war efforts. In the 1930s, income taxes were extended to middle-class Americans to help fund New Deal programs. World War II brought further changes in 1943 with the introduction of payroll withholding, making tax collection more efficient and expanding compliance.

Major reforms came in 1986 with the Tax Reform Act, a landmark bipartisan law. The act simplified the tax code by reducing the number of tax brackets, lowering overall rates, and eliminating many loopholes and tax shelters. It broadened the tax base by limiting deductions and incentivized homeownership through mortgage interest deductions. On the corporate side, it reduced rates while curbing certain deductions and credits. Designed to be revenue-neutral, the act remains one of the most significant overhauls of the tax system.

THE TAX CUTS AND JOBS ACT

The Tax Cuts and Jobs Act (TCJA), signed into law in December 2017, was the most significant overhaul of the U.S. tax code in over 30 years. It introduced sweeping changes to both individual and business taxes, aiming to simplify the tax system, reduce rates, and promote economic growth.

KEY CHANGES FOR INDIVIDUALS

• Income Tax Rates: The TCJA retained the seven-bracket structure but lowered rates across most brackets, reducing the top rate from 39.6% to 37%.
• Standard Deduction: The standard deduction nearly doubled, reducing the number of taxpayers who itemize deductions. The personal exemption was eliminated.
• State and Local Tax (SALT) Deduction: SALT deductions were capped at $10,000 annually, disproportionately impacting taxpayers in high-tax states.
• Child Tax Credit: The credit was increased to $2,000 per child, with a portion refundable.
• ACA Individual Mandate: The penalty for not having qualifying health insurance was effectively eliminated by reducing it to $0 starting in 2019. Read on in The Policy Circle’s Affordable Care Act Insight.
• Most individual provisions are set to expire after 2025 unless extended by Congress.

KEY CHANGES FOR BUSINESSES

• Corporate Tax Rate: The corporate tax rate was permanently reduced from 35% to 21%, bringing the U.S. closer to international norms.
• Expensing: Businesses can fully expense short-lived capital investments for five years.
• Territorial Tax System: The TCJA shifted the U.S. toward a territorial system, exempting foreign-earned dividends from U.S. taxation while introducing measures like base erosion anti-abuse tax (BEAT) to discourage profit shifting.

ECONOMIC IMPACT

Thus, while the TCJA successfully reduced the cost of capital and encouraged investment, its long-term impact on federal revenue was higher than initially projected, with losses ranging from $1.1 trillion to $1.9 trillion before accounting for debt service costs or unforeseen economic events.

Investopedia and the Tax Policy Center take more in-depth looks at the changes from the TCJA.

SaveSave

FEDERAL

Article I, Section 8 of the Constitution grants Congress the power to “lay and collect taxes, duties, imposts, and excises” to “provide for the common defense and promote the general welfare.” However, the Founders placed limits on Congress’s ability to impose direct taxes by requiring that such taxes be apportioned among the states based on population. This restriction was removed with the ratification of the 16th Amendment in 1913, which allowed Congress to levy income taxes without apportionment among states.

This constitutional framework established the foundation for federal taxation, enabling Congress to create a tax system that has evolved significantly over time. Since the 1940s, individual income taxes have consistently provided between 40% and 50% of total federal revenue, making them the single largest federal government funding source today.

STATE AND LOCAL

State governments primarily rely on income and sales taxes for revenue, while local governments depend heavily on property taxes, which account for the majority of their tax collections. Localities also collect sales and income taxes in some areas, contributing to their overall revenue streams. These taxes fund essential public services such as education, public safety, and infrastructure.

Sales taxes are a significant component of state tax systems, collected by most states and many localities. Combined state and local sales tax rates can vary widely, with some areas imposing higher overall rates due to additional local taxes. Sales taxes are often considered more pro-growth than income taxes because they tend to introduce fewer economic distortions.

State income taxes are another critical revenue source, with structures varying across states. Recent years have seen notable reforms, including rate reductions to enhance competitiveness and attract residents or businesses. Most states also levy corporate income taxes but contribute a smaller share of total revenue compared to personal income or sales taxes.

PRINCIPLES FOR FISCAL POLICY

Before jumping into the challenges, it’s important to remember the goal of tax policy. Taxation aims to raise the revenue necessary to meet government spending needs while minimizing economic distortions. A well-designed tax system should encourage work, savings, and investment while remaining equitable, efficient, and simple. Tax policy reform is especially critical during periods of slow economic growth. Overly burdensome taxes can stifle productivity and innovation. By reducing tax rates or simplifying the tax code, governments can create a more competitive environment that incentivizes individuals and businesses to invest in the economy.

Fiscal policy plays a key role in shaping economic outcomes. Lowering taxes allows individuals to retain more of their earnings, stimulating consumer spending, and business expansion. At the same time, policymakers must address the looming debt crisis by prioritizing spending restraint. Rising taxes could place an unsustainable burden on future generations without fiscal discipline and hinder long-term growth. A tax system that fosters economic growth can help mitigate these challenges.

Ultimately, tax reform should balance revenue sufficiency with economic freedom. A well-crafted tax policy can fuel growth by fostering a competitive environment that rewards innovation and investment while ensuring government programs are sustainably funded.

For more, see The Policy Circle’s Economic Growth and Federal Debt Briefs.

MARGINAL TAX INCENTIVES

Marginal tax rates play a crucial role in shaping economic behavior by influencing decisions to work, save, or invest. High marginal tax rates, particularly for low-income individuals transitioning out of welfare programs, can create disincentives to increase earnings. This is because additional income often results in reduced benefits, effectively imposing a high “tax” on incremental earnings. Critics argue that such structures trap individuals in poverty by making it harder to achieve upward mobility. Policymakers face the challenge of balancing progressivity in the tax code with minimizing these adverse incentives to ensure that work and investment remain attractive across all income levels.

For a visual guide, check out this breakdown of how marginal taxes work (3 min).

See The Policy Circle’s Poverty Brief for more on marginal tax rates and their adverse effects.

PROPERTY TAXES

Property taxes are a cornerstone of local government funding, providing essential revenue for schools, infrastructure, and public safety. They are also hotly debated due to fairness concerns, the reliance on property values, and challenges in maintaining stable revenue streams.

Fair property assessments are a major challenge in property taxation. Research shows that lower-value homes are often over-assessed relative to market prices, while higher-value properties are under-assessed. Some individuals advocate for reforms, such as sliding-scale tax rates based on income or property value, to alleviate these burdens. Others propose pooling property tax revenue regionally or statewide to ensure equitable funding for services like education across municipalities. While these approaches could reduce disparities, critics worry that centralized funding might disconnect taxpayers from local decision-making and priorities.

An alternative reform gaining traction is taxing land value instead of property value. Under this system, taxes would be based solely on the unimproved value of land rather than the total value of land and buildings. Advocates argue that this approach would incentivize denser development and discourage speculative hoarding of undeveloped land, potentially easing housing shortages in high-demand areas. However, implementing such a system would require significant changes to zoning laws and face resistance from landowners accustomed to the current system.

LOCAL DEPENDENCY AND TAX VOLATILITY

Local governments depend heavily on property taxes, often with limited options to diversify their revenue sources. This reliance becomes problematic during economic downturns when property values decline, leading to reduced tax revenues and forcing municipalities to cut services like garbage collection or streetlight maintenance. To offset these losses, some localities increase property tax rates, but this can place additional financial strain on households already facing declining home values. Critics argue that this over-reliance highlights the need for more balanced revenue systems that incorporate other sources like sales or income taxes.

Property taxes are a cornerstone of local government funding. Proposed reforms include diversifying local revenue sources, implementing sliding-scale tax rates, or taxing land value instead of property value to promote equitable taxation and encourage efficient land use. The last option could ease housing supply issues, but would likely require changes in zoning laws, which can be difficult to implement. See The Policy Circle’s Housing Brief for more on zoning laws.

All potential solutions face practical and political hurdles. The debate over property taxes reflects broader tensions between fairness, stability, and local autonomy. Policymakers must weigh these trade-offs carefully while addressing systemic inequities that disproportionately affect vulnerable communities.

INCOME VERSUS CONSUMPTION TAX SYSTEM

The debate between income and consumption tax systems centers on whether to tax what people earn or spend, with each approach presenting distinct economic implications and policy challenges. The federal government relies heavily on personal income taxes, both on labor income (wages and salaries) and capital income (interest, dividends, and capital gains). Critics argue that taxing capital income reduces investment returns, discouraging savings and economic growth.

Consumption taxes, such as sales tax, offer an alternative approach by taxing spending rather than earnings. Proponents contend that consumption taxes encourage savings and investment by allowing individuals to defer consumption in favor of accumulating wealth. This system could also enable lower income tax rates, particularly for labor income and capital gains, which advocates believe would enhance economic efficiency and competitiveness.

However, critics maintain that consumption taxes disproportionately burden middle- and lower-income families because these groups spend a larger share of their income on necessities (regressivity). Further, implementing broader consumption taxes at the federal level would require significant administrative changes.

One proposed compromise is to modify the existing income tax system by eliminating taxes on returns from investment—such as capital gains—while maintaining taxes on labor income. Advocates suggest this approach would incentivize saving and investment while minimizing the regressive effects associated with consumption taxes. Opponents counter that removing capital income taxes could result in substantial revenue losses unless offset by increased economic activity or other tax measures.

The tension between income and consumption tax systems reflects broader debates about fairness, economic growth, and revenue stability. Policymakers must weigh these trade-offs carefully to design a tax system that balances fairness with efficiency while ensuring sustainable revenue generation.

CORPORATE TAXES

Federal corporate taxes consistently provide between seven and 10% of the budget. Corporate income is generally subject to two levels of taxation, once when it is earned at the corporate level and again when income is distributed as a dividend to shareholders.Policymakers grapple with balancing economic competitiveness, fairness, and revenue generation. Historically, the U.S. corporate tax rate was among the highest globally, incentivizing practices like “inversions,” where companies relocated their parent entities to lower-tax countries, and profit-shifting, where income generated overseas was kept in offshore accounts to avoid higher U.S. taxes.

The TCJA addressed these issues by reducing the corporate tax rate from 35% to 21%, bringing it closer to international norms. It also introduced measures to encourage repatriation of overseas profits and penalize profit-shifting to low-tax jurisdictions. While these changes aimed to make the U.S. more competitive, evidence suggests that profit-shifting remains a challenge, with companies continuing to exploit loopholes and offshore strategies.

Critics argue that lowering corporate tax rates alone does not address aggressive tax avoidance practices and reduces federal revenue. Proposed reforms include stricter regulations on profit-shifting and increased transparency requirements for multinational corporations. Others advocate for international cooperation, such as a global minimum corporate tax rate, to level the playing field and discourage companies from exploiting low-tax jurisdictions.

At the state level, corporate taxes contribute less revenue than personal income or sales taxes, but remain an important funding source. States with higher corporate taxes often face criticism for discouraging business investment, while states with lower rates risk underfunding essential programs or relying too heavily on other revenue sources.

The debate over corporate taxes highlights tensions between promoting economic growth and ensuring fairness in taxation. Policymakers must carefully weigh these trade-offs to design a system that attracts businesses while maintaining fair and sustainable revenue streams.

THE STATE AND LOCAL TAX DEDUCTION

The State and Local Tax (SALT) deduction allows taxpayers to deduct certain taxes paid to state and local governments—such as property taxes, income taxes, or sales taxes—from their federal taxable income. Historically, the deduction was unlimited, providing significant relief to taxpayers in high-tax states by reducing the burden of double taxation. However, the 2017 Tax Cuts and Jobs Act (TCJA) introduced a $10,000 cap on SALT deductions, dramatically altering its impact. The cap disproportionately affected taxpayers in states with higher tax burdens, such as New York and California, where many households pay well above the limit.

Proponents of the cap argue that it prevents the federal tax code from subsidizing high-tax states and increases federal revenue while sparing lower-income taxpayers who typically do not itemize deductions. Critics contend that the cap unfairly penalizes residents in high-tax states, shifting a larger share of their tax burden to the federal level. The SALT deduction cap is set to expire at the end of 2025, reigniting debates over whether it should be repealed or extended. Policymakers must weigh fairness concerns against fiscal considerations as they deliberate its future.

THE TAX GAP

The tax gap is the difference between taxes that are owed and what is actually collected, or an estimate of unpaid taxes. The IRS says this gap occurs due to errors, fraud, and lack of resources to enforce collections. The last time the IRS formally published data on the tax gap, it used data from 2011 to 2013; at that time, the report showed annual losses of $688 billion. Reports suggest that the growth of cryptocurrencies and foreign-source income, combined with estimates of a significant tax gap, indicate that IRS research may have underestimated the extent of tax losses.

More funds for the IRS could increase revenue and provide a return on the investment. Bipartisan consensus supports more highly skilled investigators and better technology to help close the tax gap, particularly in light of growing budget deficits and federal debt, which have ballooned in due to the coronavirus pandemic. About 85% of individuals voluntarily pay their taxes on time, leaving 15% to be tracked down.

See these six recommendations to close the tax gap.

As Benjamin Franklin famously observed, “nothing can be said to be certain, except death and taxes.” While taxes are inevitable, how they are structured remains within our control—making it essential to pursue a system that is simple, fair, and sustainable.

Advocates for a simpler tax code show that simplifying the system can ease compliance, reduce market interference, and provide predictability for businesses and individuals to make confident growth and investment decisions. A tax system that is simple, fair, and sustainable is more than just an ideal. It is a necessity for fostering economic growth and trust in government. The power to influence this lies with informed citizens who demand smarter and more equitable policies.

Measure: Find out what your state and district are doing about taxation.

• Do you know about your state’s budget and finances?
  • How much debt does your state have?
• What are your state’s tax policies?

Identify: Who are the influencers in your state, county, or community? Learn about their priorities and consider how to contact them, including elected officials, attorneys general, law enforcement, boards of education, city councils, journalists, media outlets, community organizations, and local businesses.

• Who are the members of the departments of treasury, revenue, or taxation in your state?
• What steps have  your state’s or community’s elected and appointed officials taken?
  • Has there been any recent tax-related legislation in your state?

Reach Out: You are a catalyst. Finding a common cause is a great opportunity to develop relationships with people who may be outside of your immediate network. All it takes is a small team of two or three people to set a path for real improvement. The Policy Circle is your platform to convene with experts you want to hear from.

• Find allies in your community or in nearby towns and elsewhere in the state.
• Foster collaborative relationships with neighbors, community organizations, and local businesses or entrepreneurs.

Plan: Set some milestones based on your state’s legislative calendar.

• Don’t hesitate to contact The Policy Circle team, [email protected], for connections to the broader network, advice, insights on how to build rapport with policy makers and establish yourself as a civic leader.

Execute: Give it your best shot. You can:

• Apply for The Policy Circle’s CLER Program to join a community of like-minded women learning better skills to be effective business and civic leaders in their communities.
• Investigate your own finances – how much is taken out of your paycheck in taxes?
• Reach out to local business owners and entrepreneurs about their tax burdens, or to your local chamber of commerce.
• Investigate how your state compares to others in terms of tax revenue from income, sales, and corporate taxes.
• See the National Conference of State Legislature’s State Tax Actions Database for recent actions in your state.
• Consider contacting a tax professional in your community to hear their thoughts about tax policy in your state.
• Write to your federal, state, or local government officials about your interest in tax policy.

• Americans for Tax Reform, the enforcer of the Taxpayer Protection Pledge
• The Tax Foundation
• The Tax Policy Center
• The National Taxpayers Union

These think tanks also have top-notch scholars who promote free-market policies with an eye towards economic growth and limited government:

• The Mercatus Center at George Mason University
• Manhattan Institute
• American Enterprise Institute

Video Resources:

What’s Taxing About Taxes? (14 min).

The Progressive Income Tax: A Tale of Three Brothers (5 min).

Lower Taxes, Higher Revenue (5 min).