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
Tax
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.
