Why do we pay taxes? Federal income tax is the biggest source of government funding (2024)

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• The law obliges us to pay taxes, which in turn provide everything from health care and Social Security to education and defense.
• We pay taxes to the federal, state, and local governments, each of which uses the funds for different priorities.
• Taxes support the people and foster economic growth, giving government legitimacy.
• See Personal Finance Insider's picks for the best tax software.

Taxes, though not particularly popular, are key to fostering economic growth and development and to achieving the common goal of a prosperous and functional society.

While we usually think about them around the start of a new year when the federal income-tax season rolls around, we interact with them every day. In addition to our income, we are taxed on the purchases we make and the property we own. It all amounts to trillions of dollars a year in the US and pays for everything from Social Security and the military to trash removal and the upkeep of community greenspaces.

Why do we pay taxes?

Total US federal spending for fiscal 2021 was about $10.1 trillion, according to data compiled by USAspending.gov. State government general fund spending, meanwhile, was $931.7 billion, according to a report from the National Association of State Budget Officers. All that money has to come from somewhere. That's why we pay taxes: to help fund governments at all levels.

The taxes collected by governments foster economic growth and development, paying for essential goods and services such as infrastructure, health care, and education in order to achieve the common goal of a prosperous, functional, and orderly society, says the World Bank, which provides development finance for collecting public revenue. Taxes are also a key ingredient in the social contract between citizens and the government. How they're collected and spent can determine a government's very legitimacy.

"At their most basic level, taxes address the 'free-rider' problem," says Poppy MacDonald, president at USAFacts, a not-for-profit and nonpartisan civic initiative that makes it easy to access and understand US government data. "If government didn't require citizens to pay for services, those services would be underfunded and, as a result, underprovided."

Each level of government uses the funds it raises in different ways, as each is responsible for different types of services. On the federal level, the government is tasked with large-scale programs, such as defending the country and providing social safety nets in the form of Social Security and Medicare. State spending is focused on things like education, transportation and public housing. Localities spend similarly to states, but tend to put more toward services including fire safety, sanitation, and parks and recreation.

Why do we pay federal taxes?

The federal individual income tax is one of the taxes withheld from your paycheck, and is more than likely the biggest item deducted. It's also the federal government's largest single source of revenue.

If you make money — however you make it — it's more than likely that income will be taxed. The federal income tax is progressive, meaning those with larger incomes pay a greater share. Rates range from as little as 10% on the lower end of the scale to as much as 37% on some income at the high end.

The Federal Insurance Contributions Act, better known as FICA, is the law that established the payroll tax that is deducted from each paycheck. It is separate from the federal income tax and helps fund both Social Security and Medicare programs, which provide benefits for retirees, the disabled, and children.

There are more federal taxes as well. For example, corporate income tax is levied on business profits. The estate tax is a tax on your right to transfer property when you die. Excise taxes are imposed on various goods, services and activities and may be imposed on the manufacturer, retailer or consumer, depending on the specific tax. Cigarettes, alcoholic beverages, and gasoline are among those items that are subject to an excise tax. Excise taxes also make up a relatively small and volatile portion of state and local tax collections, according to the non-profit Tax Foundation.

"At tax time, we are hyper focused on our income tax rates and how much income tax we will pay," says Gena Jones, founder and CEO of Jones Tax Group. "These other taxes should also be part of the tax conversation because they can be substantial."

So where does it all go? For fiscal 2021, the largest portion of the US government spending, almost 20%, was in the income security category, which includes programs ranging from unemployment compensation and military retirement to the earned income tax credit and nutrition assistance. Medicare accounted for 13.7%, Social Security was 11.8%, national defense was 11.1%, and health was 10%. The 2021 figures were heavily skewed by massive spending to address the economic impact of the COVID-19 pandemic.

Fiscal year 2021 federal spending by budget function

Source: USASpending.gov

"We won't really appreciate some of the things our tax dollars pay for until our hair turns gray," says Jones. "Look at the bright side, some of the taxes you pay are put into your Social Security savings account, which you can begin to withdraw at retirement age."

Why do we pay state taxes?

As with the federal government, states need their residents to pay taxes in order to fund services. The way in which they do so differs from state to state, with some states choosing not to collect an income tax while others forgo sales tax. All states levy some form of property tax, with state-local tax burdens as of 2019 averaging 10.3% of national income. New Yorkers got hit the hardest at 14.1%, according to data compiled by the Tax Foundation.

Other areas of state spending include transportation, corrections, and other public health programs.

Why do we pay local taxes?

Just like with state taxes, local taxes can vary. They can include taxes on property, sales, income, as well as miscellaneous items like water fees and parking meters. Local governments often get a significant portion of their revenue from sources such as grants from federal and state governments, and from charges for business-like entities that provide services like public utilities, hospitals, and public transit, MacDonald says.

The bottom line

We pay taxes to fund our federal, state and local governments so they can function properly and provide necessary services.Each particular government has its particular focus, with the big-picture spending on things like defense and Social Security placed in the hands of the federal government. States take on education and health, while local governments pay for things such as your garbage collection and child's school transportation.