Business taxation is a constantly changing and controversial subject covering a wide array of taxes. Some are imposed by the federal government, others by state and local governments. Some are paid directly by businesses, while others are added into the price of products and, depending on the market, paid by consumers, producers, or combinations of both consumers and producers.
Taxes have existed as long as organized societies have existed, and the most powerful people in a society usually control taxation. For example, the Earl of Mercia in 11thcentury Coventry, England, only agreed to reduce taxes after his wife, Lady Godiva, agreed to ride through the village naked on a horse. In U.S. elementary schools, students learn about the early American colonists’ protests against taxation without representation, dramatized by the Boston Tea Party.
At its conception in 1781, the federal government was given no power to tax citizens. When Congress, in 1791, allowed an excise tax on spirits, it resulted in a revolt by farmers in western Pennsylvania, known as the Whiskey Rebellion. In 1798 Congress levied a tax of $2 million, apportioned among the states based on population, to pay off part of the debt accumulated during the Revolutionary War. The tax was levied based on the value of ASSETS including dwellings, land, and slaves.
Throughout the 1800s, TARIFFs were the major source of federal tax revenue. Tariffs were generally easier to impose, since most ports were open and visible, and they were less controversial than PROPERTY TAXES or excise taxes. Tariffs were imposed for two purposes: to raise money for government and to protect domestic industries against foreign COMPETITION.
During the Civil War, the federal government imposed both property and INCOME taxes. After the war, the income tax was discontinued, but the Bureau of Internal Revenue continued to collect “sin and vice” taxes on tobacco and liquor. Tariffs remained the major source of federal tax revenue until World War I. Income taxation, reimposed in 1913 as a popular response to the concentration of power and WEALTH among elite industrialists, was expanded and used to pay for U.S. involvement in the war.
Today, while most of the federal government’s tax revenue comes from personal income tax and SOCIAL SECURITY payments, business taxation remains a significant and complex part of our tax system. Some of the major taxes imposed by the federal government on businesses include corporate income tax, excise taxes, Social Security, and Medicare. Corporate income tax is, as the name suggests, a tax on the net income of companies. It is a progressive tax, or the percentage of corporate income paid as taxes, increasing as income increases. Numerous deductions and allowances reduce the income subject to taxation. The federal tax laws contain thousands of special provisions for CORPORATIONs reducing or eliminating their tax liability. Businesses can also avoid corporate taxation by either electing sub-S classification (for small businesses) and distributing profits to SHAREHOLDERS, who then declare the profits as personal income; or by creating PARTNERSHIPs, which also do not pay corporate taxes and, like sub-S corporations, distribute income to partners.
Excise taxes are taxes on the manufacture or sale of a PRODUCT. Businesses pay excise taxes to both the federal government and state governments. The major excise taxes in the United States are gasoline, tobacco, and alcohol taxes, taxed at a set amount per unit of output. For example, wine is taxed at $1.07 per gallon (for wine with less than 14-percent alcohol). Beer is taxed at $18 per barrel. As part of the tobacco settlement, in 1998 the federal government significantly raised the excise tax on tobacco. There are also many obscure excise taxes, including taxes on coal, recreational vehicles, tires, and the production of machine guns and destructive devices.
To businesses, excise taxes are a cost of doing business, and as such they are included in the price of a product. How much of the tax is paid by consumers in the form of higher prices and how much is absorbed by businesses as a cost depends primarily on the ELASTICITY OF DEMAND for products. Elasticity of demand is consumers’ sensitivity or responsiveness to price changes. For example, the government raised the excise tax on tobacco by 75 cents per pack in 1998 and settled the liability lawsuit costing the tobacco companies billions of dollars over the next 25 years. At the same time, the price of cigarettes went up an amount almost equal to the combined excise tax and settlement costs. Because demand for tobacco products is very inelastic (among addicted smokers), the tax was transferred to consumers. If, instead, consumers had significantly reduced their purchases of tobacco products in response to the higher price, much of the tax would have been incurred by the businesses.
The third major type of tax paid by businesses is Social Security. Employers and employees each contribute a set percentage of income, approximately 6 percent to Old Age, Survivors and Disability (OASDI), up to a limit of about $80,000 of wages and salaries annually. The limit increases with inflation. Both employers and employees contribute about 1.5 percent of wages, with no limit on income to pay for Medicare. Since these taxes are only paid on wage income, businesses, especially small businesses, can legally avoid paying some of these taxes by distributing income in the form of DIVIDENDs. On the other hand, self-employed people pay both the employer and employee’s share of Social Security taxes.
Most states generate the majority of their tax revenue using sales, property, and personal income taxes. Business taxation varies considerably among states, with some states taxing business inventories and business income. Most cities impose property taxes on businesses but also offer tax breaks for companies bringing jobs to the community. Supporters of these practices call them incentives, while opponents call them CORPORATE WELFARE.
See also TAX SHELTERS.