Tax Revenue: What It Is, How It Works, Types

What Is Tax Revenue?

Tax revenue is money collected by a government body from its constituents for public spending. Taxes may be based on income, property value, or sales of goods and services.
In the U.S., federal tax revenue mostly derives from taxes on the income of individuals and the profits of businesses. State and local governments derive much of their revenue from income taxes and sales taxes. Local governments may also impose income taxes, property taxes, school taxes, and sales taxes.
In the U.S., Social Security payments are not categorized as taxes. They are "contributions" made by individuals that presumably will be returned to them down the road in the form of direct benefits.

Key Takeaways

  • Tax revenue in the U.S. includes money collected by federal, state, and local governments.
  • The U.S. relies primarily on individual and business income taxes. Other countries rely on consumption taxes, such as value-added taxes that are imposed at each stage of a product's production and sale.
  • Corporate income tax accounts for 9% of American tax revenue.

Understanding Tax Revenue

In the United States, tax revenue is comprised of funds collected by federal, state, and local governments through taxes on income and profits, sales, and use taxes levied on goods and services. State and local taxes may also be imposed on the ownership and transfer of property.

Additional federal tax revenue is received through payroll taxes including Social Security contributions mandated by the Federal Insurance Contributions Act (FICA) and unemployment tax required by the Federal Unemployment Tax Act (FUTA). These, however, may be categorized as contributions, not taxes, as they are meant to be returned to the individual in the form of benefits. States also impose Medicare taxes and payroll taxes. such as state unemployment taxes that can partially offset FUTA levies.

At the federal level, the income tax is by far the largest source of government revenue.

There are miscellaneous smaller sources of revenue, such as the proceeds of federal auctions of spectrum rights for broadcast and wifi use, and entrance fees collected at national parks.

Many countries rely less on income taxes than the U.S. does. They collect more of their revenue from consumption taxes, usually imposed as value-added taxes (VATs) on goods and services and taxes that directly support social welfare programs such as universal healthcare.

Low or no state income tax doesn't mean tax-free. Florida has no state income tax but its sales and excise taxes are 10% higher than the national average. This effectively means that low-income residents pay a higher tax rate than wealthy residents.

Types of Tax Revenue 

U.S. Federal Taxes

Generally, U.S. income taxes apply to money that is received from any source, including wages, salaries, rents, investment gains, licensing royalties, gambling winnings, and any other income unless expressly excluded. The U.S. imposes both individual and corporate income taxes.

U.S. tax law provides extensive, special rules for determining the tax rate on income from different sources and from different types of business activities. Income taxes are not owed on the value of gifts, inheritances, or qualified educational scholarships. However, donors' and decedents’ estates are liable for gift and estate taxes on substantial transfers.

State Taxes

State tax systems vary. Seven states impose no income tax on residents. They rely on property or sales and use taxes to fund state services. Some states tax decedents’ estates and some tax inheritances.

States and local governments also receive infusions of cash from the federal government. In 2022, the federal government sent about $1.2 trillion to state, local, tribal, and territorial governments in the form of federal grants.

Most income and estate and gift taxes, as well as some property taxes, are graduated, applying higher tax rates at higher amounts or values.

Residents of states without income taxes are subject to local taxes to fund local services such as schools, police services, and roadworks.

Flat-Rate Taxes

FICA, FUTA, Medicare, and most state payroll taxes apply at flat rates with a cap on the annual amount subject to the particular tax. These taxes produce revenue to support the specific programs identified with them.

Employers are required to withhold income and payroll taxes on employees’ compensation and to pay the withheld amounts, together with the employers’ own share of payroll taxes, directly to the IRS.   

Sales and Use Taxes

Sales and use taxes are consumption taxes added to the prices charged for goods and services. These are collected by the sellers or service providers who must pay them directly to the government imposing the tax.
Most of these taxes apply only to the amount charged to the ultimate consumer of the product or service. The items subject to these taxes and the applicable rates differ by jurisdiction.

Most tax systems exempt essential food and medications from sales tax. Sales and use taxes usually are stated separately on bills.

Value-Added Taxes

Value-Added or VAT taxes are imposed by 174 countries, but not by the U.S.

The VAT tax generally is collected at each stage of the exchange or transfer of goods, not merely upon the transaction price for the ultimate consumer. For example, a buyer of raw materials for a factory will pay a VAT tax on the purchase; the wholesale buyer of the finished products will pay a VAT tax on the transaction, and the consumer will pay a VAT tax on the ultimate purchase.

U.S. Tax System vs. Other Nations

The U.S. relies primarily on individual income taxes for revenue. Individual income taxes imposed at the federal, state, and local levels comprised the largest portion of total U.S. tax revenue, estimated at 49% in 2023.

Social insurance taxes accounted for 37% of the total tax revenue while consumption taxes amounted to about 2%. The corporate income tax accounted for only a little under 9%.

Among the 38 countries (including the United States) that comprise the Organisation for Economic Co-operation and Development (OECD), the U.S. is the only nation that does not have a VAT tax.

In 2021, the simple percentage average of total revenue by source for all 38 OECD countries including the U.S. was: consumption taxes (VAT, excise taxes, and sales and use taxes), 32.1% of total tax revenue; social insurance taxes, 25.7%; individual income taxes, 23.9%; and property taxes, 5.6%. Corporate income taxes accounted for 9.8%.

These overall OECD averages contrast greatly with the U.S. percentages for some sources. For example, as noted above, the U.S. receives far less of its total tax revenue from excise taxes, only 2%, but receives a much larger portion from income taxes, 50%.

U.S. and OECD consumption tax rates also differ significantly. Among the 46 U.S. states that impose sales taxes, Louisiana had the highest combined state and local rate for 2023 at 9.55%, while Alaska’s was the lowest at 1.76%. 

Typically, VAT rates are much higher. In 2021, the average VAT rate for EU countries and the United Kingdom, which concluded its departure from the EU that year, was 21%.

In times of economic crisis, some countries temporarily lower their VAT rates below their standard levels. As of 2023, the minimum standard rate is 15%.

Which States Have No Income Taxes?

States that do not collect income taxes include Alaska, Florida, Nevada, South Dakota, Tennessee, and Wyoming.

If you're considering relocating to escape state income taxes, first consider your destination's property taxes, sales, and excise taxes. The key figure is the overall tax burden.

How Can I Find Out How My Tax Dollars Are Spent?

One way to find out how the federal government used your income tax dollars is by using an interactive tool created by the nonprofit National Priorities Project. This tool crunch the numbers to show how much you contributed to health spending, defense spending, and other federal programs based on the amount of income tax you paid for the year.

How Much Does the Federal Government Collect and Spend Per Year?

The federal government collected about $5 trillion in revenue during the 2022 fiscal year, an increase of about 14.3 percent over the previous fiscal year. It spent about $6.5 trillion, meaning it had to raise about $1.5 trillion by borrowing.

The Bottom Line

The U.S. tax system is a rare if not unique example of a federal government funded mostly by individual income taxes. Most nations rely on a value-added tax, or VAT, that taxes products at each stage of their production, including their final sale. Many of those nations also have income taxes but they make a relatively small contribution to total revenue.
Article Sources
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