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income tax

A tax consists of a rate and a base. Because income is the base for the income tax, a central question is: What constitutes income? Different theoretical concepts of income exist in economics, accounting, and taxation. The base of income to which the federal income tax rate structure applies is taxable income as constitutionally and statutorily defined. Thus, the concept of taxable income is grounded in theory and modified by political dynamics and administrative concerns.

From its modern introduction in 1913, the rate structure for the individual income tax has been progressive, meaning that tax rates graduate upward as the base of taxable income increases. Different tax rates apply to ranges of income, called brackets. Over time, the number of brackets and tax rates that apply to them have varied greatly. The tax rate applied to the last dollar of taxable income earned by a taxpayer is called the marginal tax rate. Total income tax as a percentage of total taxable income is the average tax rate, whereas total income tax as a percentage of total economic income is the effective tax rate.


Until the Civil War, federal revenues came from relatively low tariff rates imposed on a broad base of imported goods and from excise taxes. However, tariffs and excise taxes could not support escalations in government spending caused by the Civil War. Drawing on the example of the British Parliaments adoption of an income tax in 1799 to help finance the Napoleonic Wars, the U.S. Congress adopted the first federal income tax in 1861 to partially finance the Civil War. Legislators regarded the war-motivated income tax as an indirect tax because neither real nor

A tax collector in his office.

personal properties were taxed directly. The constitutionality of the tax was not challenged, and it expired in 1872.

During the post-Civil War years, high tariffs, often established to protect selected industries from foreign competition, and excise taxes were the major sources of revenues. By the early 1890s, tax structure was a political issue, with debate centering on the equity of the tax burden. In

1894, with strong Democratic support, a modest income tax was adopted. The first $4000 of income was exempt from taxation, and the initial tax rate was 2 percent. The prevailing view was that this tax would apply to high-income taxpayers and corporations without extending to the wages and salaries of working people.

In 1895, the U.S. Supreme Court declared the income tax unconstitutional in the case of Pollock v. Farmers Loan and Trust Co. on the basis that it was a direct tax. Article I, Section 9 of the original U.S. Constitution provided that No capitation, or other direct tax shall be laid, unless in proportion to the census. After the income tax was declared unconstitutional, Democrats began to introduce constitutional amendments to permit it. By the early 1900s, political support had broadened to include progressive Republicans. The Sixteenth Amendment, which legalized an income tax, was submitted to the states in 1909 and ratified in 1913. At this time, roughly 2 percent of American households paid the new tax.


Various aspects of the federal income tax have changed since its inception.

World War I and Depression Years. During World War I, the Democrats altered the tax by adopting highly progressive rates and structuring the base to consist of the incomes of corporations and upper-income individuals. Additionally, an excess profits tax was imposed. This was a progressive tax on above-normal profits, and it generated most of the new tax revenue raised during World War I. Together the income tax and excess profits tax became an explicit means for the redistribution of income. To administer these taxes, the Bureau of Internal Revenue reorganized along functional lines, expanded in size, and employed such experts as accountants, lawyers, and economists. In 1916, reporting at the source was adopted, which required corporations to report salaries, dividends, and wages to the Treasury Department.

When the Republicans took control of the presidency and Congress in 1921, taxes on corporations and upper-income taxpayers were reduced, the excess profits tax was repealed, and the tax rate structure was adjusted to be less progressive. Many preferences were incorporated into tax law in the form of deductions, and the preferential taxation of capital gains was adopted. A capital gain is a gain that results from the sale of a capital asset, such as shares of stock in a corporation. In 1932 under President Hoover and in 1935 and 1937 under President Roosevelt, tax rates increased and the tax base expanded. However, the income tax was not a dominant policy focus during the 1930s, partially because the federal government relied heavily on excise taxes and debt to obtain funds to support government activities.

World War II. The most significant impact of World War II on the individual income tax was to transform it to a mass tax that was broadly based and progressive. In 1941, changes were made to both rates and base. Higher tax rates were adopted and lower exemptions were allowed, thus expanding the base. Higher tax rates were adopted again in 1942. With the inclusion of a surtax, tax rates ranged from 13 percent on the first $2000 of taxable income to 82 percent on taxable income in excess of $200,000. The number of taxpayers increased from 3.9 million in 1939 to 42.6 million in 1945. At the end of the war, 60 percent of households paid the income tax. The efficiency of collection was enhanced by the adoption of payroll withholding in 1943. By 1944, the individual income tax generated about 40 percent of federal revenues.

For corporations, progressive tax rates, also called graduated tax rates, were introduced in 1935, repealed in 1938, and remained flat during World War II. However, wartime corporations were subject to a graduated tax on excess profits, with the maximum rate of 50 percent after an allowance for a substantial credit.

During the World War II years, there was a major shift in the taxing power of the federal government relative to state and local governments. Federal revenues, as a percent of total

taxes collected by all levels of government, increased from 16 percent in 1940 to 51 percent in 1950.

With some modifications, the basic structure of the income tax remained in place during the post-World War II years and continues to the present. Individual tax rates were reduced from wartime highs, and the tax base began to narrow with the adoption of exemptions, deductions, and credits. Inflation in the 1960s and 1970s created a condition called bracket creep. Taxpayers whose monetary incomes were increasing because of inflation, but with no equivalent increase in purchasing power, were pushed into higher tax brackets and thus subject to higher marginal tax rates. Because the corporate rate structure was not progressive, bracket creep did not apply to corporations. Although the corporate and individual income taxes had generated roughly the same revenue in 1950, by 1980, partially as a result of bracket creep, the individual income tax generated four times the revenue of the corporate tax.

After World War II. During the post-World War II years, the tax system was used increasingly as a means of financing. A government may deliver services by direct payment or indirectly by subsidy through a reduction in tax. For example, the deduction for home mortgage interest provides a tax subsidy for investing in housing. The term tax expenditure is used to describe subsidies for various purposes achieved by use of exemptions, deductions, and credits. Exempt income is not subject to tax. A deduction reduces the amount of income that is subject to tax, and a credit represents a direct reduction in the amount of tax liability. From 1967 to 1982, tax expenditure increased from 38 percent to 73.5 percent of tax receipts. Tax expenditure provisions complicate the determination oftaxable income, the base for the income tax.

The sophisticated study of tax policy, which continues to the present, began on a widespread basis during the post-World War II period. Central questions concerned the impact of tax policy on the amount of investment, the movement of capital, and labor-force participation.

From 1980 until 2000. The 1980s began with the adoption of the Economic Recovery Tax Act (ERTA) during President Reagans term. A key provision of this act was the indexing of tax rates for inflation to eliminate bracket creep. ERTA provided for significant reductions in tax rates and began to reduce the role of the income tax in the nations revenue system. During the 1980s, interest in tax reform grew, culminating in passage of the Tax Reform Act of 1986. The goal of this act was to be revenue-neutral, neither increasing nor decreasing revenues. It provided for a reduction in tax rates by expanding the tax base through the elimination of some tax expenditures.

After passage of the 1986 Tax Reform Act, attention shifted to the taxation of capital gains and replacement of the income tax. Beginning in 1987, capital gains and ordinary income were taxed in the same manner. Then preferential treatment was reintroduced for capital gains. Commonly proposed alternatives to the income tax include the value-added tax and national sales taxes, two taxes for which the tax base would be consumption rather than income. Another alternative is the flat tax on income. In theory, with one single tax rate-a flat tax-all taxpayers would pay the same proportion of taxable income in taxes. If the base of taxable income were defined as earned income, taxpayers receiving only interest and dividends would be excluded from the payment of taxes. Currently interest and dividends are subject to a double tax. Corporations pay income tax on the earnings from which dividends and interest are paid, and individuals pay income tax on dividend and interest income that they receive. Most flat tax proposals eliminate double taxation.


The Internal Revenue Service (IRS), which administers the income tax, is part of the U.S. Department of Treasury. Adapting to changes in technology to achieve the most efficient processing of information is a major challenge for the IRS. For many years the IRS was organized on a

geographical basis, but in 1998 it was reorganized into four functional divisions differentiated by type of taxpayer.

For corporate and individual taxpayers that report on a calendar-year basis, annual tax returns are due on or before March 15 and April 15, respectively, following the close of the calendar year. Providing that the tax due is paid, time extensions for filing returns may be obtained. Although the closing dates for the quarters differ, both individuals and corporations are subject to the payment of estimated tax in quarterly installments. Taxpayers who fail to file tax returns or fail to pay taxes are subject to monetary penalties, fines, and possibly prison sentences.


Wisconsin was the first state to adopt an income tax-in 1911. Massachusetts and New York soon followed by adopting income taxes when faced with problems related to World War I. Most other states adopted the income tax as a response to revenue crises created by the Great Depression. At the state level, definitions of taxable income differ from the federal definition and differ among states. Exemptions, deductions, and rates of taxation vary among states. As of January 2000, Nevada, South Dakota, Washington, and Wyoming did not impose individual or corporate income taxes; Alaska, Florida, New Hampshire, and Texas did not impose an individual income tax; and Michigan did not impose a corporate income tax. Formulas are used to allocate the income of multistate corporations among the states in which they operate.

(see also: Taxation)


Brownlee, W. Elliot. (1996). Federal Taxation in America. New York: Cambridge University Press.

Witte, John F. (1985). The Politics and Development of the Federal Income Tax. Madison: University of Wisconsin Press.

Jean E. Harris


The Independence Standards Board (ISB) was established in May 1997 as a result of discussions between the American Institute of Certified Public Accountants (AICPA) and the U.S. Securities and Exchange Commission (SEC). The various securities laws enacted by Congress and administered by the SEC recognize that the integrity and credibility of the financial reporting process for public companies depends, in large part, on auditors remaining independent from their audit clients. The operating policies of the ISB are designed to permit timely, thorough, and open study of issues involving auditor independence and to encourage broad public participation in the process of establishing and improving independence standards. The mission of the ISB is to establish independence standards applicable to audits of public entities in order to serve the public interest and to protect and promote investors confidence in the securities markets.


The ISB is a board of eight members, supported by an Independence Issues Committee, an executive director, and other support staff. The ISB operates as an independent body, funded by the AICPA SEC Practice Section of its Division of CPA Firms (SECPS). Accordingly, the ISB has authority to make public statements on matters relating to the subject of auditor independence in connection with audits of public entities without clearance from the SECPS or the AICPA board of directors. ISB board members serve on a part-time basis. Four are public members, three are senior partners of SECPS member firms, and one is the president of the AICPA or the presidents designee. Public members are supposed to be prominent individuals of high integrity and reputation who understand the importance of investor protection, the U.S. capital markets, and the accounting profession. The appointment of the initial board was made by the SECPS Executive Committee after consultation with the SEC and the president of the AICPA. The terms of the

board members are staggered and may be of varied lengths. Following the appointment of the initial board, successor public members will be nominated for three-year terms by the existing public members of the board. New members from SECPS member firms will be nominated for three-year terms by the SECPS Executive Committee subject to the approval of the AICPAs board of directors. The entire board will elect replacement members from those slates ofnomi-nees. The board selects its own chairperson from among the four public members.


The chair of the ISB serves a three-year term. The chair has powers and responsibilities relating to the appointment and supervision of personnel at the ISB, the distribution of work among such personnel, and the use and expenditure of funds by the ISB within the budget constraints approved by the ISB. The chair also has the authority to establish and appoint persons to task forces following approval by the ISB and after consultation with the executive director and others. The chair provides the leadership in identifying the pronouncements the ISB will issue, including, if necessary and appropriate, the authority, hierarchy, and exposure process for each pronouncement. All proposed standards will be exposed for public comment for a minimum of thirty days.


The ISB has a full-time executive director and, as necessary or appropriate, other full-time professional and administrative staff. The ISB staff fields telephone and other inquiries concerning independence issues in the manner that the board directs and pursuant to policies established by the board. In responding to inquiries, the ISB staff provides informal interpretations or guidance to the inquiring parties. As appropriate, the ISB staff informs the board regarding issues raised in such inquiries that might benefit from more comprehensive consideration by the board and, to the extent delegated or assigned by the board, the Independence Issues Committee (IIC). The ISB and its staff address independence

inquiries that arise, and the ISB understands that the SEC will encourage registrants and auditors to look to the ISB and its staff to address such matters. Further, the ISB understands that the SEC staff expects to refer specific independence-related issues that may arise to the ISB. Absent express ratification by the board, ISB staff interpretations will be considered as applying only to the particular parties directly affected by the interpretation, who may rely on such interpretation. The executive director advises and consults with the AICPA, including its Professional Ethics Executive Committee, as appropriate, on independence issues of interest to the AICPA. A public file on all ISB meetings is kept for public reference and inspection for a reasonable period of time consistent with the public interest in the

AICPA library.


The Independence Issues Committee (IIC) assists the ISB in establishing independence standards through the timely identification and discussion of emerging independence issues within the framework of existing authoritative literature. The IIC also addresses broader interpretative issues, including those that emerge from inquiries fielded by the ISB staff, and communicates its consensus on such issues to the board. The IIC makes publicly available its consensuses and the rationales or bases for such conclusions.

The IIC is comprised of nine certified public accountants (CPAs), drawn from SECPS member firms that audit SEC registrants, who are knowledgeable about the existing independence literature and are in positions to be aware of emerging practice issues as they develop. The SECPS Executive Committee nominates the nine members of the IIC, in consultation with and subject to the approval of the ISB. The ISB specifies the terms of the IIC members. The ISB names the chair from the nine members of the IIC.

The meetings of the IIC are usually open to the public, but sessions or portions of sessions may be closed to the public if they deal with (1) administrative matters, (2) matters that may cause substantial harm or injury (a rare occur-

rence), or (3) matters involving or relating to advice of counsel; all such closed sessions must be authorized by the chair or his or her designee, and in no instance can the SEC staff be excluded from these sessions. For the IIC to reach a consensus, at least six IIC members must approve the judgment or determination and no more than two IIC members may oppose it. On reaching a consensus, the IIC will promptly forward the matter to the ISB for ratification. If a majority of the ISB ratifies the consensus, the ISB understands that the SEC will consider such consensus as having substantial authoritative support.


The ISB may seek information about independence matters by holding a public hearing. The basis for a public hearing generally will be an exposure draft, although the ISB may also determine to hold a public hearing for any other purpose. Each public hearing will be conducted by one or more members of the ISB or IIC, the executive director, or technical staff pursuant to procedures approved by the ISB for such hearing. The ISB will publicly announce its intent to hold a public hearing at least sixty days prior to the hearing, unless a shorter period (but in no event less than thirty days) is considered appropriate by the ISB, in any manner reasonably designed to inform the public.

Any individual or organization may request to be heard at a public hearing, and, to the extent practicable, the ISB will attempt to schedule all those making timely requests. Submission of written comments, a position paper, or an outline of a proposed oral presentation will generally be a condition of being heard. Materials submitted to the ISB in this connection will constitute a part of its public file.

More information is available from Independence Standards Board, 6th floor, 1211 Avenue of the Americas, New York, NY 10036-8775; (212)596-6133 (telephone); (212)596-6137 (fax); or http: www.cpaindependence.org.

(see also: American Institute of Certified Public Accountants; Auditing; Securities and Exchange Commission)

C. Richard Baker


(see: Economic Cycles)


(see: Management: Authority and Responsibility)


Information processing may be defined as the manipulation of data to produce useful information. Over the past several years, the explosion of sophisticated computer software has dramatically changed the way computer users create documents. When word-processing, spreadsheet, and database software packages first became available to the public in the late 1970s and early 1980s, they were very different. The user interface, menus, and procedures were quite different depending on the program. As the years passed and computer software became more sophisticated, the software programs began to share many common features. Today, computer software not only shares common features, it is extremely compatible-that is, information created in one software package can be shared with that of another.

In todays modern office, computer documents often require that a combination of software packages be used together. For example, it might be necessary to place a spreadsheet in a word-processing document or a spreadsheet graph on one of the slides in a presentation file. This ability to integrate software applications is one of the most useful features of using Microsoft Windows and other software designed to be used in the Windows environment.

Integration simply means the sharing of information among applications. Windows allows

the user to use different software packages as if they were parts of a single program. Shelley, Cashman, and Vermaat (2000) explain that integrating these software programs allows the user to move quickly among applications and transfer text and graphics easily. The Windows environment offers three ways that information can be integrated: (1) the clipboard, (2) linking objects, and (3) embedding objects.


Software running in the Windows environment makes it very easy to copy and move text from one software application to another. The user can copy or move text, graphics, or other objects from one place to another using the clipboard application. For example, a chart created in Excel could be copied and pasted into a written report created in Word. To complete this procedure successfully, the user must first select the desired text or object. Then the user may choose to copy or cut (move) the selected text from the edit menu. Shortcuts usually exist for these two commands, such as clicking a button on the toolbar. If the user copies the selected text, an exact copy of the original text will be placed on the clipboard. If the user cuts the text, however, the original text will be moved to the clipboard. Text that is placed on the clipboard will stay there until it is pasted somewhere else. To paste the information, the user selects the paste option from the edit menu. It is important to remember that only one object can be stored on the clipboard at a time. When a new object is copied or cut to the clipboard, whatever information was previously there will be removed.

Because multiple software programs (applications) can run at the same time in Windows, the user can place information on the clipboard, open another program, and paste the information in the desired location in the new program. This method is the simplest and most frequently used for sharing information among software applications.

Copying/cutting and pasting among different applications has several advantages. This proce-

dure saves time, eliminates keying errors, and allows the user to tie various applications together as if they were part of a single program.


Some limitations exist in using the clipboard to copy and move information between applications. Once the information has been pasted from the clipboard to the new location, all ties between the original source document and the pasted information cease to exist. The destination document, which contains the pasted information, will not be automatically updated if any changes are made to the original source document. This limitation creates a problem in many of todays fast-paced work environments. For example, many annual reports created in word-processing packages contain financial status information that is produced in a spreadsheet package. If the financial data are changed or updated in any way, the information that was previously pasted into the actual word-processing report would not show those changes.

To rectify many of these situations, Windows has developed Object Linking and Embedding (OLE). The first OLE method, linking, allows the user to share information among applications by creating a connection (or link) between the original source document and the destination document. If the source is altered after an OLE has been established, the destination document will automatically update and show all the changes that have been made. When data are linked between two documents in this way, the data are not actually stored in a destination file. The destination document stores only the information it needs to link back to the original source document. If changes need to be made to the linked information, the changes must be made and saved in the original source application.

Linking is very useful when there is a large group of users who need to view the source data. These users can access the source data and then view the updates if changes are made frequently. To link a selected object that has already been copied to the clipboard, the user must choose the

Paste special option on the edit menu. Within this menu, the user selects the Paste link option.

The user may find several advantages by deciding to link objects. Linking does not waste the computers memory or storage space because it never duplicates information in two separate locations. Linking allows the user to place objects such as those created in other applications or sound and video clips into word-processing, spreadsheet, and presentation documents that have no other options for performing such procedures.

Linking can also be very beneficial when different users have to share computing tasks. For example, the accounting department might be responsible for the creation of all spreadsheets and graphs within a company. If the accounting department saves the files on the network drive, employees throughout the company can link these spreadsheet and graph files into their necessary applications. If changes need to be made to the original spreadsheet files, the accounting department would be responsible for making these updates. When other users throughout the company open their destination documents that contain the link, the changes can either be automatically updated (called an automatic link) or can be updated when the user requests it (called a manual link). Most Windows software has an Update Now feature that allows a user to decide when to update a link. A lock feature is also widely available in case the user does not want the link to be accidentally updated.

One important point to remember when linking information is that the destination document must always be able to locate the original source document. If a destination file was copied to a floppy disk and taken to another computer, all linked files must also be copied onto the floppy disk in order for the links to be able to find their connections.


The second type of OLE process, embedding, is another feature of Windows. When information from one application is embedded into another, the information becomes part of the destination

file. Although this process requires the use of more memory, it allows the destination file to be self-supporting. When the embedded object needs to be edited or updated, the user must double-click on the object. This double-clicking opens the source application file inside an editing window. All the necessary menus and features will be available in this window for use in editing the source information. After making the appropriate changes to the embedded object, the user simply clicks outside of the editing window and returns to the destination document. Because the user does not have to keep opening and closing the source application file, a great deal of time is saved. Another advantage of this feature is that the user can make changes in the embedded object and the destination file without touching the original source document and vice versa. In keeping with linking objects, the user must be able to access all source applications in order to make changes in any embedded objects. The user does not, however, need to have access to the original source application in order to print or view the destination document. To embed an object, the user follows the same procedures as for linking an object except that in the Paste special menu the Paste option is selected instead of the Paste Link option.

OLeary and OLeary (1996) explain that embedding text or objects is often favored over linking objects in the following situations: (1) The size of the file is not important; (2) users have access to source applications, but not the original source file; and (3) the embedded data is changed only occasionally. For example, if the user intends to use the shared information at a location removed from the source file, it would be necessary to embed the object in order to edit the information. When linking, however, the user must always have access to the source file via a network or an accessible fixed drive.

Unfortunately, not every software program supports OLE features. If a software package supports OLE features, it is called OLE-aware. The first version of OLE was introduced with Windows 3.x; therefore, nearly all software created to

run under the Windows environment is OLE-aware.


Information processing is a broad concept covering the many aspects of manipulating data to produce useful information. This article has addressed the specific skills of integrating information by using the clipboard, linked objects, and embedded objects. With the increased sophistication of software packages, the concepts and skills used in copying/cutting and pasting to the clipboard, linking objects, and embedding objects are no longer difficult to use. Software integration allows a number of software application packages to be used as if they were a single package, thereby increasing efficiency and productivity within the work environment. Various departments within an organization are able to access files from any desktop and link them to necessary applications. Users are able to save time and eliminate keying errors. As these activities become more commonplace, it may be necessary for computer users within organizations to update their skills in these areas.


OLeary, Timothy J., and OLeary, Linda I. (1996). Microsoft Office Integration. New York: McGraw-Hill.

Shelly, G. B., Cashman, T. J., and Vermaat, M. E. (2000). Microsoft Office 2000: Introductory Concepts and Techniques. Cambridge, MA: Course Technology.

J. D. Thomerson Donnie McGahee Mary Alice Griffin


Throughout history humanity has tried to invent new ways to simplify the problem-solving process. With each generation, people have used various tools and methods to help them process information. Information is defined as letters, symbols, or numbers that are used to express an idea.

The history of information processing goes back five thousand years to the abacus, one of the earliest known counting devices. This first reported calculator or processor was developed in ancient Egypt and in the Far East during the thirteenth century. The abacus consisted of wires strung across a rectangular frame. The frame divides each wire into two sections: The one on the top contains two beads, and the one on the bottom contains five beads. Each top bead represents the quantity 5; each bottom bead represents the quantity 1. Each wire represents a place: units, tens, hundreds, and so on. Computations were done by moving the correct number of beads up to the top of the frame.

The invention of logarithms by John Napier was a landmark in the history of mathematics, enabling people to multiply or divide large numbers quickly and accurately. As a product of logarithms, Napier invented a tool, nicknamed Napiers Bones, that was used to multiply, divide, and extract square and cube roots.

In 1642 a French philosopher and mathematician, Blaise Pascal, invented the first adding machine, called the Pascaline. It consisted of a series of ten-toothed wheels connected to numbers that could be added together by advancing the wheels by a correct number of teeth. The Pascaline was used until it was replaced by the electronic calculator in the 1960s.

In the 1820s, Sir Charles Babbage, an inventor and genius, developed a mechanical device that could be programmed to perform simple mathematical calculations. He called his invention the Difference Engine. In 1834, he designed the Analytical Engine, which could do more complicated calculations. It could multiply, divide, add, subtract, and even print out an answer. It included an input device, a storage facility to hold numbers for processing, a processor or number calculator, a control unit to direct tasks to be performed, and an output device. The concept used in the Analytical Engine is the concept used in todays general-purpose computer, which is why Babbage is considered to be the father of the modern computer and the field of study known today as operational research.

The Hollerith Tabulator was created at MIT in 1884.

In 1884, an American inventor at MIT, Herman Hollerith, filed his first patent for a system of encoding data on cards through a series of punched holes. His hand-fed press sensed the holes in punched cards as a wire passed through the holes into a cup of mercury beneath the card, closing the electrical circuit. This process trig-

gered mechanical counters and sorter bins that tabulated the appropriate data. The U.S. government used Holleriths machine to help with the 1890 census tabulation. His later machines mechanized the card-feeding process, added numbers, and sorted cards, in addition to merely counting data. In 1896, Hollerith started the Tabulating

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