Few people enjoy paying taxes, but most people benefit from taxation in one way or another. Governments impose taxes on various economic activities to raise money to fund their operations. Without taxes, governments would have few resources to devote toward programs such as education, infrastructure and defense. All taxes share a few basic factors – understanding different characteristics of taxation will help you better plan your personal finances.
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Scope of the Tax
Every tax includes a set of economic activities and individuals to whom the tax applies, and that defines the overall scope of the tax. Taxes can be imposed on many different activities and individuals For instance, a state income tax applies to income earned by individuals within the borders of a certain state.
A federal estate tax applies to all individuals in the country who leave estates behind after death. A local sales tax applies to goods and services sold within a certain geographical area, such as a city or county.
Different Tax Rates
A tax rate defines how much tax must be paid by those who incur the tax. For instance, if you work in a state with a 5 percent state income tax rate, you must pay 5 percent of the income you earn to the state government. You might live in a county with 6 percent sales tax, then move to the next county over where the sales tax is 7 percent. When you run a small business, your income tax rate might be higher than your personal income tax rate, factoring into your decision how you want to be paid by your company.
A common characteristics of tax rates is that they often impose financial charges based on a certain percentage of the value of income or property being exchanged, but they may also impose flat charges. For instance, the cost of a marriage license in a certain state might be fixed at $100.
Read More: What Happens if You Don't File Taxes?
Collection of Taxes
Collection describes how governments obtain tax money from taxpayers. Businesses are often required to collect and send taxes to the governments that impose them. For instance, U.S. companies withhold income from employee pay and send it to the Internal Revenue Service (IRS) to cover the income taxes, Social Security taxes and Medicare taxes employees owe. On the other hand, self-employed workers must send income taxes to the government themselves, sometimes on a quarterly basis.
Progressive vs. Regressive Taxes
Taxes are often separated into two categories: progressive and regressive. Progressive taxes are taxes that tend to tax the wealthy more than those with lower income, and regressive taxes tend to impose a greater burden on those with low income. Income taxation in the U.S. is considered progressive, because those with more income face higher tax rates and, therefore, pay a higher percentage of total income toward income taxes.
Taxes that impose the same rate on all individuals, such as sales taxes, license fees and tolls, are often considered regressive, because those with less income typically end up paying a greater proportion of their total income toward such taxes.