What Are Taxes?
Taxes are mandatory contributions levied on individuals or corporations by a government entity—whether local, regional or national. Tax revenues finance government activities, including such public works and services as roads and schools, or programs like Social Security and Medicare. In economics, taxes fall on whomever pays the burden of the tax, whether this is the entity being taxed, such as a business, or the end consumers of the business’s goods.
To help fund public works and services—and to build and maintain the infrastructures used in a country—a government usually taxes its individual and corporate residents. The tax collected is used for the betterment of the economy and all living in it. In the U.S. and many other countries in the world, income taxes are applied to some form of money received by a taxpayer. The money could be income earned from salary, capital gains from investment appreciation, dividends or interest received as additional income, payment made for goods and services, etc.
Tax revenues are used for public services and the operation of the government, as well as for the Social Security and Medicare programs. As baby boomer populations have aged, Social Security and Medicare have claimed increasingly high proportions of the total federal expenditure of tax revenue. Throughout United States history, tax policy has been a consistent source of political debate.
A tax requires a percentage of the taxpayer’s earnings or money to be taken and remitted to the government. Payment of taxes at rates levied by the government is compulsory, and tax evasion—the deliberate failure to pay one’s full tax liabilities—is punishable by law. (On the other hand, tax avoidance—actions taken to lessen your tax liability and maximize after-tax income—is perfectly legal.) Most governments use an agency or department to collect taxes. In the United States, this function is performed federally by the Internal Revenue Service (IRS).
There are several very common types of taxes:
▪️ Income tax—a percentage of generated income that is relinquished to the state or federal government.
▪️ Payroll tax—a percentage withheld from an employee’s pay by an employer, who pays it to the government on the employee’s behalf to fund Medicare and Social Security programs.
▪️ Corporate tax—a percentage of corporate profits taken as tax by the government to fund federal programs.
▪️ Sales tax—taxes levied on certain goods and services; varies by jurisdiction.
▪️ Property tax—based on the value of land and property assets.
▪️ Tariff—taxes on imported goods; imposed in the aim of strengthening internal businesses.
▪️ Estate tax—rate applied to the fair market value of property in a person’s estate at the time of death; total estate must exceed thresholds set by state and federal governments.
▪️ Tax systems vary widely among nations, and it is important for individuals and corporations to carefully study a new locale’s tax laws before earning income or doing business there.
Discover the three basic tax types—
“taxes on what you earn, taxes on what you buy, and taxes on what you own.”
1. Taxes on What You Earn.
▪️ Individual Income Taxes.
An individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns.Many individual income taxes are “progressive,” meaning tax rates increase as a taxpayer’s income increases, resulting in higher-earners paying a larger share of income taxes than lower-earners.
▪️ Corporate Income Taxes.
A corporate income tax (CIT) is levied by federal and state governments on business profits, which are revenues (what a business makes in sales) minus costs (the cost of doing business).
▪️ Payroll Taxes.
Payroll taxes are taxes paid on the wages and salaries of employees to finance social insurance programs. Most taxpayers will be familiar with payroll taxes from looking at their paystub at the end of each pay period, where the amount of payroll tax withheld by their employer from their income is clearly listed.
Though roughly half of the payroll taxes are paid by employers, the economic burden of payroll taxes is mostly borne by workers in the form of lower wages.
▪️ Capital Gains Taxes.
Capital assets generally include everything owned and used for personal purposes, pleasure, or investment, including stocks, bonds, homes, cars, jewelry, and art. Whenever one of those assets increases in value—e.g., when the price of a stock you own goes up—the result is what’s called a “capital gain.”
2. Taxes on What You Buy.
▪️ Sales Taxes.
Sales taxes are a form of consumption tax levied on retail sales of goods and services. If you live in the U.S., you are likely familiar with the sales tax from having seen it printed at the bottom of store receipts.
Sales tax rates can have a significant impact on where consumers choose to shop, but the sales tax base—what is and is not subject to sales tax—also matters. Tax experts recommend that sales taxes apply to all goods and services that consumers purchase but not to those that businesses purchase when producing their own goods.
▪️ Gross Receipts Taxes.
Gross receipts taxes (GRTs) are applied to a company’s gross sales, regardless of profitability and without deductions for business expenses. This is a key difference from other taxes businesses pay, such as those based on profits or net income, like a corporate income tax, or final consumption, like a well-constructed sales tax.
Because GRTs are imposed at each stage in the production chain, they result in “tax pyramiding,” where the tax burden multiplies throughout the production chain and is eventually passed on to consumers.
GRTs are particularly harmful for startups, which post losses in early years, and businesses with long production chains.
Despite being dismissed for decades as inefficient and unsound tax policy, policymakers have recently begun considering GRTs again as they seek new revenue streams.
▪️ Value-Added Taxes.
A Value-Added Tax (VAT) is a consumption tax assessed on the value added in each production stage of a good or service.Each business along the production chain is required to pay a VAT on the value of the produced good/service at that stage, with the VAT previously paid for that good/service being deductible at each step.
The final consumer, however, pays the VAT without being able to deduct the previously paid VAT, making it a tax on final consumption. This system ensures that only final consumption can be taxed under a VAT, avoiding tax pyramiding.
▪️ Excise Taxes.
Excise taxes are taxes imposed on a specific good or activity, usually in addition to a broad consumption tax, and comprise a relatively small and volatile share of total tax collections. Common examples of excise taxes include those on cigarettes, alcohol, soda, gasoline, and betting.
3. Taxes on Things You Own.
▪️ Property Taxes.
Property taxes are primarily levied on immovable property like land and buildings.
▪️ Tangible Personal Property (TPP) Taxes.
Tangible personal property (TPP) is property that can be moved or touched, such as business equipment, machinery, inventory, furniture, and automobiles.
▪️ Estate and Inheritance Taxes.
Both estate and inheritance taxes are imposed on the value of an individual’s property at the time of their death. While estate taxes are paid by the estate itself, before assets are distributed to heirs, inheritance taxes are paid by those who inherit property. Both taxes are usually paired with a “gift tax” so that they cannot be avoided by transferring the property prior to death.
▪️ Wealth Taxes.
Wealth taxes are typically imposed annually on an individual’s net wealth (total assets, minus any debts owed) above a certain threshold.
JULIA KAGAN (2020-6-11), “What Are Taxes?”، www.investopedia.com
“The Three Basic Tax Types”, www.taxfoundation.org