Tax

From Wikicpa

A tax (also known as a "duty") is a financial charge or other levy imposed on an individual or a legal entity by a state or a functional equivalent of a state (e.g. tribes, secessionist movements or revolutionary movements). Taxes could also be imposed by a subnational entity.

Taxes may be part of a direct tax or indirect tax, and may be paid in money or as corvée labor. In modern, capitalist taxation systems, taxes are levied in money, but in-kind and corvée taxation are characteristic of traditional or pre-capitalist states and their functional equivalents.

Taxes are usually collected by a governmental agency such as the Internal Revenue Service in the United States. When taxes are not paid to a government's satisfaction, penalties such as fines, forfeiture, and imprisonment are carried out against the non-paying entity or individual. These penalties are also typically carried out by a governmental agency, such as the Federal Bureau of Investigation in the US. In most modern industrialized countries, when an individual fails to pay his government the taxes that that government demands of him, it will ultimately result in his imprisonment at the hands of the state.

The means of taxation, and the uses to which the funds raised through taxation should be put, are a matter of hot dispute in politics and economics, so discussions of taxation are frequently tendentious.

Public finance is the field of political science / economics that deals with taxation.

1 Purposes and effects of taxation
2 Tax rates
3 Types of taxes
4 Who pays
5 External links

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Purposes and effects of taxation

Funds provided by taxation have been used by states and their functional equivalents throughout history to carry out the functions such as:

military defense,
enforcement of law and public order,
protection of property,
redistribution of wealth,
economic infrastructure — roads, legal tender, enforcement of contracts, etc.,
Public works,
The operation of government itself.

Most modern governments also use taxes to fund social welfare and public services, such as:

education systems,
health care systems,
pensions for the elderly,
unemployment benefits
energy management, water and waste management systems,
public transportation.

Colonial states and moderning states have also used cash taxes to draw or force reluctant subsistence producers into cash economies.

Governments use different kind of taxes and vary the tax rates:

to distribute the tax burden between individuals or classes of the population involved in taxable activities, such as business,
to redistribute resources between individuals or classes in the population. Historically, the nobility were supported by taxes on the poor; modern social security systems are intended to support the poor, the disabled or the retired by taxes on those who are still working,
to fund foriegn aid and military aid,
to influence the macroeconomic performance of the economy (the government's strategy for doing this is called its fiscal policy) (see also tax exemption),
to modify patterns of consumption or employment within an economy, by making some classes of transaction more or less attractive.

The resource taken from the public through taxation is always somewhat greater than the amount which can be used by the government. The difference is called compliance cost, and includes for example the labour cost and other expenses incurred in complying with tax laws and rules.

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Tax rates

Taxes are most often levied as a percentage, called the tax rate, of a certain value, the tax base (how much income and assets one has, earns, spends, inherits, etcetera). An ad valorem tax is one where the tax base is the value of a good, service, or property. Sales taxes, tariffs, property taxes, inheritance taxes, and value added taxes are different types of ad valorem tax. An ad valorem tax is typically imposed at the time of a transaction (sales tax or value added tax (VAT)) but it may be imposed on an annual basis (property tax) or in connection with another significant event (inheritance tax or tariffs).

An important distinction when talking about tax rates is to distinguish between the marginal rate and the average rate. The average rate is the total tax paid divided by the total amount the tax is paid on, while the marginal rate is the rate paid on the next dollar of income earned. In a “progressive” tax system, these can be very different. For example, if income is taxed on a formula of 5% from $0 up to $49,999, 10% from $50,000 to $99,999, and 15% over $100,000, a taxpayer with income of $175,000 would pay a total of $18,750:

((0.05*50,000) + (0.10*50,000) + (0.15*75,000))

=18,750

His average rate would be 10.7%:

(18,750/175,000)

= 0.107

However, his marginal rate would be 15%.

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Types of taxes

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Income tax

Income taxes are typically structured to be progressive taxes. For this reason, it is generally advocated by those who think that taxation should be borne more by the rich than by the poor, even to the point of serving as a form of social redistribution. Some critics characterize this tax as a form of punishment for economic productivity. Other critics charge that income taxation is inherently socially intrusive because enforcement requires the government to collect large amounts of information about business and personal affairs, much of which is considered proprietary and confidential.

The crucial invention permitting the reliable collection of high income taxes was direct withholding of taxes from payrolls by employers; this works because most people in modern societies are salaried workers. This reduces the perceived burden of the tax, because employees never handle the money. Direct withholding also discourages cheating, because it requires the collaboration of employers, and as there are fewer employers than employees, the government's enforcement efforts can be deployed more effectively. However, direct withholding also has some drawbacks: it puts part of the burden of processing taxes on the employer, and it also complicates matters when the employee is in a situation where he or she should pay significantly less or more than what is expected from its salary (because of tax-deductible expenses, or side revenues). Direct withholding is the method of collection of choice in most countries implementing income taxes, with the exception of France, where direct withholding is periodically discussed, but has so far not been implemented.

Where income tax is not collected at source, it may become easier to cheat by lying about one's affairs. The government may then require that employers report the amounts they pay to employees.

Income tax, in addition to income, generally takes into account a variety of factors. Certain expenses, such as work-related expenses, donations to charities etc..., may be tax-deductible: that is, they are subtracted from the taxable revenue. Investments in some impoverished areas or industrial sectors may be encouraged through tax breaks (reduced rates). Donations to charities may be partly subtracted from the tax, in an original form of subsidy. Because of various exemptions, rebates etc..., income tax codes tend to be complicated. In some countries such as the United States, individuals often hire the service of a tax accountant so as to find the best way to reduce their tax.

Income tax fraud is a problem in most, if not all, countries implementing an income tax. Either one fails to declare income, or declares nonexistent expenses. Failure to declare income is especially easy for non-salaried work, especially those paid in cash. Tax enforcement authorities fight tax fraud using various methods, nowadays with the help of computer databases. They may, for instance, look for discrepancies between declared revenue and expenses along time. Tax enforcement authorities then target individuals for a tax audit a more or less detailed review of the income and tax-deductible expenses of the individual.

Income tax may be collected from legal entities (e.g., companies) as well as natural persons (individuals), although, in some cases, the income tax on legal entities is levied on a slightly different basis than the income tax on individuals and may be called, in the case of income tax on companies, a corporate tax or a corporate income tax.

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Retirement tax

Some countries with social security systems, which provide income to retired workers, fund those systems with specific dedicated taxes. These often differ from comprehensive income taxes in that they are levied only on specific sources of income, generally wages and salary (in which case they are called payroll taxes). A further difference is that the total amount of the taxes paid by or on behalf of a worker is typically considered in the calculation of the retirement benefits to which that worker is entitled.

These taxes are sometimes regressive in their immediate effect. For example, in the United States, each worker, whatever his or her income, pays at the same rate up to a specified cap, but income over the cap is not taxed. A further regressive feature is that such taxes often exclude investment earnings and other forms of income that are more likely to be received by the wealthy. The regressive effect is somewhat offset, however, by the eventual benefit payments, which typically replace a higher percentage of a lower-paid worker's pre-retirement income.

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Capital gains tax

A capital gains tax is the tax levied of the profit realised upon the sale of an asset. In many cases, the amount of a capital gain is treated as income and subject to the marginal rate of income tax.

If such a tax is levied on inherited property then it can act as a de facto probate or inheritance tax.

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Corporation tax

Corporation tax is a tax on corporate earnings (and often includes capital gains) of a company. Earnings are generally considered gross revenue less expenses. However, corporate expenses that relate to capital expenditures are rarely deducted in full (such as the entire cost of a company truck) and are often deducted over the useful life of the asset purchase. Generally, industrialized countries also use a regressive rate of tax upon corporate income.

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Sales tax

Sales taxes are a form of excise levied when a commodity is sold to its final consumer. Retail organizations contend that such taxes discourage retail sales. The question of whether they are generally progressive or regressive is a subject of much current debate. People with higher incomes spend a lower proportion of them, so a flat-rate sales tax will tend to be regressive. It is therefore common to exempt food, utilities and other necessities from sales taxes, since poor people spend a higher proportion of their incomes on these commodities, so such exemptions would make the tax more progressive. This is the classic "You pay for what you spend" tax, as only those who spend money on non-exempt (i.e. luxury) items pay the tax.

A small number of US states rely entirely on sales taxes for state revenue, as those states do not levy a state income tax. Such states tend to have a moderate to large amount of tourism or inter-state travel that occurs within their borders, allowing the state to benefit from taxes from people the state would otherwise not tax. In this way, the state is able to reduce the tax burden on its citizens.

The US states that do not levy a state income tax are Alaska, Florida, Nevada, South Dakota, Texas, Washington state, and Wyoming. Additionally, New Hampshire and Tennessee only levy state income taxes on dividends and interest income. Of the above states, only Alaska and New Hampshire do not levy a state sales tax. Additional information can be obtained at the Federation of Tax Administrators website.

The sales tax has come into national attention with the growing movement for a "FairTax" federal tax system, which is, in all reality, simply a national retail sales tax. That subject is covered more in depth in the Wikipedia entry "FairTax".

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Property taxes

A property tax is usually levied on the value of property owned, usually real estate. Property taxes may be charged on a recurrent basis, or upon a certain event.

The two most common type of event driven property taxes are stamp duty, charged upon change of ownership, and inheritance tax, which is imposed in many countries on the estates of the deceased.

In contrast with a tax on buildings, a land value tax is levied only on the unimproved value of the land ("land" in this instance meaning the economic term, i.e., all natural resources). Land tax has long been recognised as the only tax which does not distort market relations. Some political economists claim that because land is not the product of labour it should be the only tax.

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Inheritance tax

Some believe that inheritance taxes do not have any harmful effect on the economy and may even be beneficial as they encourage consumer spending by the elderly. However, some also believe them to discourage productivity and to disrupt the continuity of family-owned businesses.

Usually, the tax is designed with blanket coverage but with large exceptions for obvious things like food and clothing. Household goods are exempt as long as they are kept or used within the household. However, any otherwise non-exempt object can lose its exemption if regularly kept outside the household. Thus, tax collectors often monitor newspaper articles for stories about wealthy people who have lent art to museums for public display, because the artworks have then become subject to personal property tax. And if an artwork had to be sent to another state for some touch-ups, it may have become subject to personal property tax in that state as well.

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Who pays

In the United States, the Congressional Budget Office produces a number of reports on the share of all federal taxes paid by taxpayers of various income levels. Their data for 2002 shows the following: (Table 2)

The top 1% of taxpayers by income pay 33% of all individual income taxes, and 22.7% of all federal taxes.
The top 5% of taxpayers pay 54.5% of all individual income taxes, and 38.5% of all federal taxes.
The top 10% of taxpayers pay 67.4% of all individual income taxes, and 50% of all federal taxes.
The top quintile (20%) pays 82.5% of all individual income taxes, and 65.3% of all federal taxes.

Their numbers also show, that when broken down by quintile, the social insurance taxes are regressive on an effective tax rate basis only for the highest percentile, though that quintile pays the largest share of social insurance taxes (44%). However, when returns to social insurance (in the form of retirement benefits) are accounted for, social insurance taxes are effectively progressive. (Table 1)

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