6.2: Sources of Taxation and Kinds of Taxes

Learning Objectives

1. Identify the levels of government that impose taxes.
2. Define the different kinds of incomes, assets, and transactions that may be taxed.
3. Compare and contrast progressive and regressive taxes.

Any government that needs to raise revenue and has the legal authority to do so may tax. Tax jurisdictions reflect government authorities. Federal, state, and municipal governments impose taxes in the United States. Similarly, in many countries, there are national, provincial or state, county, and municipal taxes. Regional economic alliances, such as the European Union, may also impose taxes.

Jurisdictions may overlap. Federal, state, and local governments may all tax income. Reporting income and paying taxes can be complicated for individuals who earn income in more than one state or live in one state and work in another. Governments tax income because it is a way to tax broadly based on the ability to pay. Most adults have an income from some source, even if it is simply a government payment.

Income tax is usually a progressive tax: the higher the income or the more to be taxed, the greater the tax rate. The percentage of income that is paid in tax increases as income rises. Those income categories are called tax brackets (Table 6.2.1 ).

Source: Federal Income Tax Rates and Brackets (www.irs.gov/filing/federal-income-tax-rates-and-brackets)

Table 6.2.1 : U.S. Income Tax Brackets in 2023 (Single Filing Status)

If your taxable income was between			Your tax bracket is
$ 0	and	$ 11,000	10%
$ 11,001	and	$ 44,725	12%
$ 44,726	and	$ 95,375	22%
$ 95,376	and	$ 182,100	24%
$ 182,101	and	$ 231,250	32%
$ 231,251	and	$ 578,125	35%
$ 578,126	and	above	37%

Tax is levied on income from many sources:

• Wages (selling labor)
• Interest, dividends, and gains from investment (selling capital)
• Self-employment (operating a business, or selling a good or service)
• Property rental
• Royalties (rental of intellectual property)
• “Other” income, such as alimony, gambling winnings, or prizes

A sales tax or consumption tax taxes the consumption financed by income. In the United States, sales taxes are imposed by state or local governments; as yet, there is no national sales tax. Sales taxes are more efficient and fair in that consumption reflects income. Income levels determine the ability to consume and, therefore, the level of consumption. Consumption is also hard to hide, making sales tax a good way to collect taxes based on the ability to pay. Consumption taxes typically apply to all consumption, including nondiscretionary items such as food, clothing, and housing. Opponents of the sales tax argue that it is a regressive tax. Low-income taxpayers spend a higher percentage of their incomes on nondiscretionary purchases than those with higher incomes. Another example of a regressive tax is Social Security Taxes, also known as the Federal Insurance Contributions Act (FICA).

Excise taxes are taxes on specific consumption items such as alcohol, cigarettes, motor vehicles, fuel, or highway use. In some states, excise taxes are justified by the discretionary nature of the purchases. They may be criticized as exercises in social engineering (i.e., using the tax code to dictate social behaviors). For example, people addicted to nicotine or alcohol tend to purchase cigarettes or liquor even if an excise tax increases their cost; therefore, they are a reliable source of tax revenue.

Property taxes are used more by local governments. State, municipal, provincial, and county taxes are all examples. Taxes are most commonly imposed on real property (land and buildings), but may also apply to personal assets (e.g., vehicles and boats). Property values theoretically reflect wealth (accrued income) and thus the ability to pay taxes. Property values are also a matter of public record (real property is deeded, boats or automobiles are licensed), which allows for more efficient tax collection.

Estate taxes are taxes on the transfer of wealth from the deceased to the living. Estate taxes are usually imposed on the very wealthiest. Because death and the subsequent dispersal of property are legally a matter of public record, estate taxes are generally easy to collect. Estate taxes are controversial because they can be seen as a tax on the very concept of ownership, particularly for incomes that have already been taxed and saved, or stored as wealth and property.

A summary of the kinds of taxes used by the three different jurisdictions is shown in Table 6.2.2 .

Table 6.2.2 : Taxes and Jurisdictions

Type of Tax	National or Federal	Provincial or State	County or Municipal
Income	✓	✓	✓
Sales		✓	✓
Excise	✓	✓	✓
Property		✓	✓

Summary

• Governments at all levels use taxes as a source of financing
• Taxes may be imposed on the following:
  • Incomes from
    • wages
    • interest, dividends, and gains
    • rental of real or intellectual property
  • Consumption of discretionary and nondiscretionary goods and services
  • Wealth from
    • asset ownership
    • asset transfer after death
• Taxes may be
  • progressive, such as the income tax, in which you pay in proportion to your income
  • regressive, such as a sales tax, in which you pay proportionally more taxes the less income you have

Exercises

1. Examine state, federal, and other tax returns you filed last year. Alternatively, estimate based on your present financial situation. On what incomes were you (or would you be) taxed? What tax bracket were you (or would you be) in? How did (or would) your state, federal, and other tax liabilities differ? What other types of taxes did you (or would you) pay and to which government jurisdictions?
2. Match the description to the corresponding tax type. (Write the number of the tax type before its description.)
   • Description:
     1. ________ tax on the use of vehicles, gasoline, alcohol, cigarettes, highways, and the like.
     2. ________ tax on the wealth and property of a person upon death.
     3. ________ tax on purchases of both discretionary and nondiscretionary items.
     4. ________ tax on wages, earned interest, capital gain, and the like.
     5. ________ tax on home and land ownership.
     6. ________ tax on purchases of discretionary items.
     7. ________ tax on items during their production as well as upon consumption.
   • Type of Tax:
     1. Property tax
     2. Consumption tax
     3. Value-added or goods and services tax
     4. Income tax
     5. Excise tax
     6. Sales tax
     7. Estate tax
3. In your financial planning journal, record all the types of taxes you will be paying next year and to whom. How will you plan to pay these taxes? How will your tax liabilities affect your budget?
4. According to Investopedia, Types of Income the IRS Can't Touch (www.investopedia.com/articles/personal-finance/062716/types-income-irs-cant-touch.asp), include veteran benefits, child support, workers' compensation, and so on. Create a list of your income sources that are protected from taxation. Poll classmates about whether they think student income can be taxed. Review this article from Ramsey Solutions about Five Tax Myths (www.ramseysolutions.com/taxes/tax-myths). Is it true that students are often exempt from income taxes?