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Individual
Income Tax | Corporate
Income Tax | Payroll
Tax | Consumption
Tax
Individual
Income Tax
An individual income tax, also
called a personal income tax, is a tax on a person's
income. Income includes wages, salaries, and other
earnings from one's occupation; interest earned
by savings accounts and certain types of bonds;
rents (earnings from rented properties); royalties
earned on sales of patented or copyrighted items,
such as inventions and books; and dividends from
stock. Income also includes capital gains, which
are profits from the sale of stock, real estate,
or other investments whose value has increased
over time.
The national governments of the United States,
Canada, and many other countries require citizens
to file an individual income tax return each year.
Each taxpayer must compute his or her tax liability-the
amount of money he or she owes the government.
This computation involves four major steps. (1)
The taxpayer computes adjusted gross income-one's
income from all taxable sources minus certain
expenses incurred in earning that income. (2)
The taxpayer converts adjusted gross income to
taxable income-the amount of income subject to
tax-by subtracting various amounts called exemptions
and deductions. Some deductions exist to enhance
the fairness of the tax system. For example, the
U.S. government permits a deduction for extraordinarily
high medical expenses. Other deductions are allowed
to encourage certain kinds of behavior. For example,
some governments permit deductions of charitable
contributions as an incentive for individuals
to give money to worthy causes. (3) The taxpayer
calculates the amount of tax due by consulting
a tax table, which shows the exact amount of tax
due for most levels of taxable income. People
with very high incomes consult a rate schedule,
a list of tax rates for different ranges of taxable
income, to compute the amount of tax due. (4)
The taxpayer subtracts taxes paid during the year
and any allowable tax credits to arrive at final
tax liability.
After computing the amount of tax due, the taxpayer
must send this information to the government and
enclose the amount due. In 1995 the average four-person
family in the United States paid about 9.2 percent
of its income in income taxes. Many taxpayers,
rather than owing money, receive a refund from
the government after filing a tax return, typically
because they had too much tax withheld from their
wages and salaries during the year. Low-income
workers in the United States may also receive
a refund because of the earned income tax credit,
a federal-government subsidy for the working poor.
The Internal Revenue Service (IRS), an agency
of the Department of the Treasury, administers
the federal income tax in the United States. Canada
Customs and Revenue Agency, which operates under
the Minister of National Revenue, administers
the tax in Canada. See Income Tax.
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Corporate Income Tax
All corporations in the United States and Canada
must pay tax on their net income (profits) to
the federal government and also to most state
or provincial governments. U.S. corporate tax
rates generally increase with income. For example,
in 1997 corporations with profits of up to $50,000
paid 15 percent in taxes, whereas corporations
with profits greater than about $18.3 million
were taxed at a flat rate of 35 percent. In Canada
the basic rate for corporations was 38 percent
in 1996. In 1994 corporate income taxes accounted
for about 9 percent of all tax revenues in the
United States and about 6.5 percent of all tax
revenues in Canada.
The corporate income tax is
one of the most controversial types of taxes.
Although the law treats corporations as if they
have an independent ability to pay a tax, many
economists note that only real people-such as
the shareholders who own corporations-can bear
a tax burden. In addition, the corporate income
tax leads to double taxation of corporate income.
Income is taxed once when it is earned by the
corporation, and a second time when it is paid
out to shareholders in the form of dividends.
Thus, corporate income faces a higher tax burden
than income earned by individuals or by other
types of businesses.
Some economists have proposed abolishing the
corporate income tax and instead taxing the owners
of corporations (shareholders) through the personal
income tax. Other students of the tax system see
the corporate income tax as the price corporations
pay in return for special privileges from society.
The most important of these privileges is limited
liability for shareholders. This means that creditors
cannot claim the personal assets of shareholders,
because the liability of shareholders for the
corporation's debts is limited to the amount they
have invested in the corporation.
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Payroll Tax
Whereas an income tax is levied on all sources
of income, a payroll tax applies
only to wages and salaries. Employers automatically
withhold payroll taxes from employees' wages and
forward them to the government. Payroll taxes
are the main sources of funding for various social
insurance programs, such as those that provide
benefits to the poor, elderly, unemployed, and
disabled. In 1994 payroll taxes accounted for
about 26 percent of all tax revenues in the United
States; in Canada, the figure was 17 percent.
For most people, payroll taxes are the second-largest
tax they must pay each year, after individual
income taxes.
The U.S. federal government levies the Tax payroll
tax at a flat 12.4 percent rate on employees'
annual gross wages up to a certain limit. The
limit, which was $68,400 in 1998, rises each year
at the same rate as the growth in average wages.
The government imposes no payroll tax on earnings
above the limit. Employers pay half the tax and
employees pay the other half. The Medicare payroll
tax is 2.9 percent of all earnings, with no cap.
Again, employers and employees split the cost
of the tax. Self-employed individuals must pay
the entire payroll tax.
Although the legislators who set up payroll taxes
intended to divide the tax burden equally between
employers and employees, this may not occur in
practice. Some economists believe that the tax
causes employers to offer lower pretax wages to
employees than they would otherwise, in effect
shifting the tax burden entirely to employees.
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Consumption Taxes
A consumption taxis a tax levied
on sales of goods or services. The most important
kinds of consumption taxes are general sales taxes,
excise taxes, value-added taxes, and tariffs.
In the United States, consumption taxes account
for only 17 percent of all tax revenues. This
is considerably lower than in most other countries.
In Canada, the figure is 27 percent, and in the
United Kingdom it is 35 percent. General sales
taxes and excise taxes are the largest sources
of revenue for state and local governments in
the United States, accounting for about 35 percent
of their total tax revenues.
Tax Attorneys