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An overview on taxation, individual
income tax, corporate income tax, payroll
tax, and consumption taxes.
Taxes are sometimes classified as either specific or ad valorem.
Specific taxes are of a fixed amount based on a number, or standard
of weight or measurement. Ad valorem taxes are based on a fixed
proportion of the value of the property with respect to which
the tax is assessed. They require an appraisal of the taxable
subject matter's worth. General property taxes are almost invariably
of this second type -- ad valorem. Ad valorem property taxes are
based on ownership of the property, and are payable regardless
of whether the property is used or not and whether it generates
income for the owner (although these factors may affect the assessed
Income tax meets the broadest definition of a property tax. The
term, however, is often limited to taxes based on real property.
See Real Property.
The most frequent use of property taxes in the U.S. is by municipal
governments, authorized to generate necessary revenue in this
fashion under state law.
Learn more about Taxation...
Taxation, system of raising money to finance government. All
governments require payments of money-taxes-from people. Governments
use tax revenues to pay soldiers and police, to build dams and
roads, to operate schools and hospitals, to provide food to the
poor and medical care to the elderly, and for hundreds of other
purposes. Without taxes to fund its activities, government could
Throughout history, people have debated the amount and kinds
of taxes that a government should impose, as well as how it should
distribute the burden of those taxes across society. Unpopular
taxes have caused public protests, riots, and even revolutions.
In political campaigns, candidates' views on taxation may partly
determine their popularity with voters.
Taxation is the most important source of revenues for modern
governments, typically accounting for 90 percent or more of their
The remainder of government revenue comes from borrowing and
from charging fees for services. Countries differ considerably
in the amount of taxes they collect. In the United States, about
28 percent of the gross domestic product, a measure of economic
output, goes for tax payments. In Canada about 36 percent of the
country's gross domestic product goes for taxes. In France the
figure is 44 percent, and in Sweden it is 51 percent.
In addition to using taxation to raise money, governments may
raise or lower taxes to achieve social and economic objectives,
or to achieve political popularity with certain groups. Taxation
can redistribute a society's wealth by imposing a heavier tax
burden on one group in order to fund services for another. Also,
some economists consider taxation an important tool for maintaining
the stability of a country's economy.
TYPES OF TAXES
Governments impose many types of taxes. In most developed countries,
individuals pay income taxes when they earn money, consumption
taxes when they spend it, property taxes when they own a home
or land, and in some cases estate taxes when they die. In the
United States, federal, state, and local governments all collect
Taxes on people's incomes play critical roles in the revenue
systems of all developed countries. In the United States, personal
income taxation is the single largest source of revenue for the
federal government. In 1997 it accounted for about 44 percent
of all federal revenues. Payroll taxes, which are used to finance
social insurance programs such as social security and Medicare,
account for more than a third of federal revenues. The United
States also taxes the incomes of corporations. In 1997, corporate
income taxation accounted for 12 percent of federal revenues.
State and local governments depend on sales taxes and property
taxes as their main sources of funding. Most U.S. states also
tax the incomes of individuals and corporations, although less
heavily than the federal government. All Canadian provinces collect
income taxes from individuals and corporations.
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.
Income taxation enjoys widespread support because income is considered
a good indicator of an individual's ability to pay. However, income
taxes are hard to administer because measuring income is often
difficult. For example, some people receive part of their income
"in-kind"-in the form of goods and services rather than
in cash. Farmers provide field hands with food, and corporations
may give employees access to company cars and free parking spaces.
If governments tax cash income but not in-kind compensation, then
people can avoid taxation by taking a higher proportion of their
income as in-kind compensation.
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.
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.
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 social security 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
A consumption tax is 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.
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