Before we get started, let me get a disclaimer out of the way. This course is for educational purposes only. Nothing in this course is meant to constitute tax or legal advice. While we made every effort to ensure that the information presented in these videos is correct as of the date of recording, tax laws are constantly changing. Not every exception or special rule will be noted in this introductory course. So you should always consider seeking out the help of a qualified tax professional to give you the best advice regarding your specific situation. Hello and welcome to the Gies College of Business at the University of Illinois. Welcome to federal taxation 1, the taxation of individuals, employees, and sole proprietors. In this course, we're going to learn about the individual income taxation system of the United States. Let's start off with a basic question. What is a tax? According to the Internal Revenue Service the agency tasked with administering and enforcing the tax laws in the United States, a tax is an enforced contribution exacted pursuant to legislative authority in the exercise of the taxing power and imposed and collected for the purpose of raising revenue to be used for public or governmental purposes and not as a privilege granted or rendered. What does this mean in plain English? Well, first, a tax is a payment that is legally required. In other words, it's not optional. For example, not paying a tax can result in both civil and or criminal penalties. Second, the payment is imposed and collected by the government. Now in the United States, federal taxes are administered, collected, enforced by the Internal Revenue Service or the IRS. The IRS is an agency within the Department of Treasury, which in turn is part of the executive branch of government. Being part of the executive branch means that the IRS operates under the direction of the President of the United States. Third, the payment is not directly tied to any benefits received by the taxpayer. Instead, taxes usually go into pools of funds to provide communal benefits such as defense, the general welfare, and infrastructure. For example, your tax dollars may go to fund road improvements, but they may or may not go into funding roads that you actually use. You can contrast this with a toll road, where you pay a toll to use a particular road. A toll is not a tax. The next basic question we need to address is why do we pay taxes? Well, simply put, taxes are used to fund governmental expenditures. As one former Supreme Court Justice put it, taxes are the price we pay for civilized society. To see how the United States spends its tax dollars. Let's take a look at this infographic from the Congressional Budget Office, Congress's official score keeper on budget issues for the US's 2019 fiscal year. Now, we're looking at fiscal year 2019 because the more recent fiscal year is 2020 and 2021 have a lot of onetime pandemic related spending. For example, economic stimulus payments and enhanced unemployment compensation benefits. By going back to 2019, we can get a look at a more typical year and spending for the US government. Here we can see that total governmental outlays are expenditures were roughly $4.4 trillion. Of that, a full one trillion dollars or roughly 23 percent of the total budget is social security spending. Social security is a benefits program consisting of retirement, disability, and survivors benefits. Now, social security is an entitlement program, meaning that if you meet certain eligibility criteria, you are entitled by law to receive the benefit. However, traditional social security benefits do vary based on your lifetime earnings that were subject to payroll or self-employment taxes. There is an earned benefit components. Next, government health care programs like Medicare, which is health care coverage for Americans aged 65 and older or disabled and Medicaid which is health care coverage for lower-income Americans, represent another roughly one trillion dollars in outlays. In addition, there is another $642 billion of other mandatory spending that includes refundable tax credits like the earned income tax credit, which provides an additional safety net to lower-income working Americans and the premium tax credit, which is the subsidized health insurance available through healthcare.gov or your state's marketplace website. This other category also includes civilian and veteran retirement benefits and other social safety net programs. Social safety net programs are programs that provide cash or in-kind assistance to struggling households. One other example is the Supplemental Nutrition Assistance Program or SNAP. Now, Social Security, Medicare Medicaid, and these other programs are called mandatory spending because Congress is not required to appropriate money to these various programs. In other words, this spending is on cruise control and Congress would have to affirmatively pass a law to alter the spending. In contrast, other expenditures are known as discretionary spending because Congress must appropriate the money for these programs annually. Defense spending is the largest type of discretionary spending, making up roughly 15 percent of the Federal budget. Everything else the Federal government does such as veterans benefits, scientific and medical research, education, agriculture, energy, space, infrastructure, foreign aid, etc. Takes up another 15 percent of the Federal budget. Finally, because the United States must borrow to cover the cost of its expenditures, roughly 9 percent of the Federal budget goes to interest payments to us debtholders. Now, looking at this next chart, we can see that the individual income tax makes up roughly half of all tax revenues that are taken in by the federal government. The next biggest source of federal tax revenues, our payroll taxes. These are taxes imposed in addition to the income tax and are used to fund the Social Security and Medicare programs. After payroll taxes, the third biggest revenue source is the corporate income tax. This is an entity level tax paid by C corporations. A type of entity will briefly discuss later in this course. Now one important thing to note here is that many businesses operate as pass-through or flow-through entities. For example, partnerships and S-corporations, meaning that the business entity itself generally doesn't pay any taxes. Instead, the income flows through to the individual owner or owners who then pay the tax. Likewise, the business income is sole proprietorships is reported directly on an individual's tax return using Schedule C. This means that there is quite a bit of business income that is included in that individual tax number, and then finally, the smallest piece of the pie is income collected by the Federal government related to excise taxes, custom taxes, estate and gift taxes, and various other types of taxes and fees. Again, we'll briefly touch on these other types of taxes later on in the course. But right now these total tax revenues fall far short a covering the total expenditures of the United States government. In fact, you've probably noticed that the total outlays were 4.4 trillion, but total revenues were only 3.5 trillion. That's a shortfall of almost $1 trillion. That's $1 trillion in a single year, a gap that has to be made up through federal borrowing. Now, the CBO projects a similar annual deaths that have approximately $1 trillion in fiscal year 2022. However, in fiscal years 2020 and 2021, the Federal government ran budget deficits of approximately $3 trillion in each year. In part because of the unprecedented amount of pandemic relief provisions enacted into law. One question on the minds of economists and policymakers is whether this level of deficits is sustainable and what negative consequences might add bring in the future. For example, will the United States need to decrease future spending? If so, what programs would have to have their budgets cut? Thinking about this question from a tax perspective, we might also ask, will tax revenues need to increase in the future? Will we have to increase tax rates, for example? Or are there specific deductions? Are credits that might need to be scaled back or eliminated to help increase federal revenues. Which taxpayers will bear the burden of any tax increases? Of course, generally no one likes to be the one who faces an increased tax burden. As one former US Senator. Eloquently explained, most people have the same philosophy about taxes. Don't tax you, don't tax me, tax that fella behind the tree. Remember, making changes in tax laws doesn't occur in a vacuum because taxpayers respond to changes. If taxes must be raised in the future, what are the implications and making those changes to the tax code? How would a taxpayer respond? How would their behavior change and how would the economy as a whole respond to a particular change? Because even when attempting to increase tax revenues, know legislator wants to impose taxes that kill economic growth. Because ideally taxes should be efficient. Raising the required amount of revenue while causing the least amount of harm to the taxpayer. One of my favorite tax quotes is from Professor John Mike Cell, Who said that we want to tax system that behaves like a pickpocket and not like a mugger. The government wants the money to finance services, but doesn't want taxpayers to light bleeding on the sidewalk, and aside from whether total tax revenues are high enough, another important question is whether the tax burden is fairly distributed. For example, you may have heard someone say that our tax code is full of loopholes. Or maybe you've heard discussion that maybe one particular group isn't paying their fair share of taxes. Ultimately, these are all very important questions that taxpayers and tax policy-makers must abate and decide on.
