The overall level of taxation is decided through budget negotiations. Although Americans allowed the government to run up deficits, spending more than it collected in taxes during the 1970s, 1980s, and the part of the 1990s, they generally believe budgets should be balanced. Most Democrats, however, are willing to tolerate a higher level of taxes to support a more active government, while Republicans generally favor lower taxes and smaller government.
From the outset, the income tax has been a progressive levy, meaning that rates are higher for people with more income. Most Democrats favor a high degree of progressivity, arguing that it is only fair to make people with more income pay more in taxes. Many Republicans, however, believe a steeply progressive rate structure discourages people from working and investing, and therefore hurts the overall economy. Accordingly, many Republicans argue for a more uniform rate structure. Some even suggest a uniform, or "flat," tax rate for everybody. (Some economists -- both Democrats and Republicans -- have suggested that the economy would fare better if the government would eliminate the income tax altogether and replace it with a consumption tax, taxing people on what they spend rather than what they earn. Proponents argue that would encourage saving and investment. But as of the end of the 1990s, the idea had not gained enough support to be given much chance of being enacted.)
Over the years, lawmakers have carved out various exemptions and deductions from the income tax to encourage specific kinds of economic activity. Most notably, taxpayers are allowed to subtract from their taxable income any interest they must pay on loans used to buy homes. Similarly, the government allows lower- and middle-income taxpayers to shelter from taxation certain amounts of money that they save in special Individual Retirement Accounts (IRAs) to meet their retirement expenses and to pay for their children's college education.
The Tax Reform Act of 1986, perhaps the most substantial reform of the U.S. tax system since the beginning of the income tax, reduced income tax rates while cutting back many popular income tax deductions (the home mortgage deduction and IRA deductions were preserved, however). The Tax Reform Act replaced the previous law's 15 tax brackets, which had a top tax rate of 50 percent, with a system that had only two tax brackets -- 15 percent and 28 percent. Other provisions reduced, or eliminated, income taxes for millions of low-income Americans.
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This article is adapted from the book "Outline of the U.S. Economy" by Conte and Carr and has been adapted with permission from the U.S. Department of State.