As far back as antiquity, governments have relied on taxation to meet their expenses. In modern society, governments rely on the revenues generated by taxation to provide the goods and services that a market economy cannot efficiently provide, such as national defense and law enforcement. Taxation is an important topic of study in economics, which devotes an entire specialty to understanding the effects of taxation and various types of tax systems.
In economics, taxation refers to government's collection of revenues from individual and business income to finance its expenses. Governments use tax revenues to finance the goods and services they provide, from roads and law enforcement to public education and national defense. The "Harper Collins Dictionary of Economics" defines taxation as government's withdrawal from the circular flow of national income model, under which households purchase goods and services from business firms using money received as income. Businesses, in turn, use the money received from households and other businesses to produce more goods and services, paying wages to households for producing these goods and purchasing other resources of production from other firms.
Public finance is the branch of economics that studies government taxation and expenditures. Economists in this specialty outline four objectives of a system of taxation: simplicity, fairness, efficiency and sufficient revenue. Simplicity means enforcement of and compliance with taxation laws should be as easy as possible. Efficiency means that taxation should strive not to distort decisions made by individuals and firms in the marketplace. A taxation system that discourages work or investment, for example, is inefficient. For most people, fairness means taxpayers in similar situations pay equal taxes, according to the Concise Encyclopedia of Economics. Advocates of a progressive tax system, in which tax liability rises with income, cite fairness as the primary benefit of such a system. Revenue sufficiency means a system of taxation generates enough money for government operations.
Economists specializing in public finance note that the four main objectives of tax policy often conflict. For example, a system that taxes everyone at an equal amount, regardless of income, may be the most simple and efficient, but raises questions of fairness. Such a system means low-wage earners pay a larger share of their earnings in taxes, while wealthier taxpayers pay proportionately less. In addition, revenue sufficiency may conflict with efficiency and fairness as well. Writing in the Concise Encyclopedia of Economics, Joseph Minarik points out that the federal government has run a budget deficit, in which expenditures exceed revenues, for many years. Higher taxes to generate more revenue and reduce the deficit may reduce efficiency in the tax system by reducing incentives to work and save. Tax increases also may place heavier tax burdens on certain individuals, raising fairness concerns.
The income tax is the best known form of taxation, but not the only one. The federal government relies mainly on income taxes as a source of revenue and taxes the incomes of individuals and corporations. In addition, many U.S. states levy a state income tax. Another type of taxation is the sales tax, a tax levied on the purchase of goods and services. Most states rely on sales taxes as a revenue source. Other forms of taxation include property taxes, assessed on the value of residential and commercial property, and excise taxes. Governments subject certain goods and services to the excise tax to place the burden of taxation on the consumer, according to the U.S. Department of the Treasury. Goods subjected to excise taxes include tires, liquor and tobacco products.