Hello and welcome to the Gies College of Business at the University of Illinois. And welcome to federal taxation one, the taxation of individuals, employees, and sole proprietors. In this course, we are going to learn about the individual income taxation system of the United States. So let's start off with the basic question, what is a tax? According to the Internal Revenue Service, the agency tasked with administering and enforcing the tax laws of 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 a public or governmental purpose and not as a privilege granted or rendered. So what does this mean in plain English? Well first, a tax is a payment that is legally required. In other words, is 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. In the United States, federal taxes are administered, collected and 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 the United States government. Being part of the executive branch means that the IRS operates under the direction of the President of the United States. And third, the payment is not directly tied to any benefits received by the taxpayer. Instead, taxes usually go into pools of funds that 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 the 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. And looking at how the United States government spends, we see that the largest chunk of expenditures comes in the form of social security, which makes up about one quarter of all federal expenditures. Social Security is a benefits program consisting of retirement, disability, and survivors benefits. 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. So there is an earned benefit component. Medicare, which is health coverage for Americans age 65 and older or disabled, makes up 15% of all government expenditures. Medicaid, which is health care coverage for lower income Americans, along with other health care programs like healthcare.gov and the premium tax credit, make up 11% of the budget. Other entitlement programs mainly social safety net programs that provide cash or and kind assistance to struggling households, takes up 14% of the budget. This category includes tax expenditures like the refundable portions of the earned income tax credit and the additional child tax credit. Defense spending is another big chunk of the budget making up roughly 15% of federal government expenditures. Everything else the federal government does such as veterans benefits, retirement benefits for federal employees, scientific and medical research, education, infrastructure, foreign aid etc, takes up only 15% of the federal budget. And finally, because the United States has to borrow to cover the costs of its expenditures, 7% of the federal budget goes to interest payments. Looking at this next chart, we see that the individual income taxes makeup roughly half of all tax revenues taken in by the federal government. The next biggest source of federal tax revenues are payroll taxes. These are taxes imposed in addition to the income tax that are used to fund the Social Security and and Medicare programs. After payroll taxes, the third biggest revenue source is the corporate income tax. This is an entry level tax paid by C corporations, which we'll briefly discuss later in the course. One important thing to note here is that many businesses operate as pass through or flow through entities like partnerships or 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, business income of a sole proprietorship is reported directly on the individual tax return. This means that there is quite a bit of business income that's included in that individual income tax number. And then finally the smallest piece of the pie is income collected by the government related to excise taxes, custom taxes, gift and estate taxes, and various other types of taxes. All tax types will briefly touch upon later in this introductory module. But right now these total tax revenues fall far short covering the total expenditures of the United States government. In fact, for the government's 2019 fiscal year, the Congressional Budget Office, Congress's official scorekeeper on budget issues, projects an estimated shortfall of about $900 billion. That's my $900 billion in a single year, a gap that will have to be made up through federal borrowing. And based on recent tax cuts and spending bill passed by Congress and signed by the president, the CBO projects those annual deficits along with the cumulative national debt to continue to increase. So one question on the minds of the economist and policy makers is whether these kinds of deficits are sustainable. And what negative consequences might it bring in the future. For example, will the United States need to decrease future spending? And if so, what programs should have their budgets cut or reduced? Thinking about this question for me a tax perspective, we might ask, will tax rates need to increase in the future to address our budget deficits occurring now? Or are there particular deductions or credits that may need to be scaled back or eliminated to help increase federal revenues? These questions bring to mind a quote from former Canadian Prime Minister Mackenzie King, who said that politicians promises of yesterday are the taxes of today. But remember making changes in tax laws doesn't occur in a vacuum, because taxpayers will respond to changes. So if taxes must be raised in the future, we also need to consider the implications of those changes. How will taxpayers adjust their behavior? How will the economy as a whole respond to a particular change in the tax code? And aside from whether 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 someone say that one particular group isn't paying their fare share of taxes. Ultimately, these are all very important questions that taxpayers and tax policy makers must debate and decide. But regardless of what the future may hold, right now is a very exciting time to study income taxation in the United States. That's because on December 20th, 2017, Congress passed. And on December 22nd, 2017, the president signed into law, an act to provide for reconciliation pursuant to Titles II and V of the concurrent resolution on the budget for fiscal year 2018. Since that name is a bit of a mouthful, this legislation is more commonly known by its former short title the Tax Cuts and Jobs Act or TCJA. The law wasn't allowed to keep this name due to some procedural rules in the senate, but for simplicity for this course we're going to stick with the name Tax Cuts and Jobs Act, or TCJA throughout the course. So why is this recent tax law such a big deal? Well, this was a $1.5 trillion dollar tax cut. And while that's pretty big, it's not even the biggest tax cut in the last decade. But even though it's not the biggest tax cut, the Tax Cuts and Jobs Act is a major revision to how the tax structure in the United States works. In other words, it changes the mechanics of the tax code more than any other tax law change in the last 30 years. But most of these changes related to individual taxation are not permanent. Instead they are scheduled to sunset or expire at the end of 2025. So in 2026, the individual tax code absent further action by Congress and the President will essentially reset to what existed for tax year of 2017. You can contrast this with most of the business tax changes made in that same law, which were permanent. So throughout this course, we'll see this new law's impact on the rules we'll be learning about. And while we'll focus on learning about new permanent tax rules and rules in effect for 2018 through 2025, we'll occasionally touch on how things were treated in years prior to 2018 and where applicable in the years after 2025. [MUSIC]
