In honor of the filing date for taxes here in the US (today), I thought we could take a look at all the different kinds of taxes that exist. Last year, I did a whole tax week that looks at some of these in greater detail. I encourage you to explore those if you want to know more about some of these taxes, but today’s post will be much shorter. This list is by no means absolute, there are hundreds of different kinds of taxes, but these are the primary sources of income for most governments, local and national.
Sales Tax: In the US, we most often see this tax as a method for states to raise revenue for themselves. Customers make purchases at the retail level (not wholesale) and pay a tax that is a percentage of the sales price. States vary the rates they charge, and the rate also varies based on the product. For example a t-shirt has one tax, food has another, and gas has still another. Some states do not have a sales tax (such as Delaware) while others may charge more than 8% on a transaction. Retailers don’t like sales taxes because they have to collect that tax from the customer. They’ll claim it deters certain sales, but I find that unlikely unless someone lives near a state border. Speaking of which, states love the sales tax since they can get revenue from people outside the state. Places where tourism is big obviously benefit quite a bit. It’s arguable that the sales tax is the fairest of all taxes. It is a tax on consumption. If you want to save on taxes, don’t buy stuff (or buy less). Those that make more money tend to consume more, so they’ll pay more taxes. The catch is near the poverty line, where almost all purchases are just for basic living.
Capital Gains Tax: This is a tax on the profit made from the sale of an asset. It’s most commonly cited when it comes to profits made from selling stocks. If you buy a share of Stock A at $10 and then sell it for $15 you have a $5 capital gain. You must pay taxes on this gain. Currently, the United States has a favorable tax treatment of capital gains thanks to the Bush tax cuts, however those are likely to be allowed to expire. States will also take a chunk of the capital gains. The great thing about this tax is it only taxes people with enough excess income to actually invest. In other words, it’s a tax the poor don’t have to think about. The problem with the capital gains tax is during times of high inflation the value of an asset may increase simply due to inflation. Selling it would result in a tax on nominal, but not real, profits. This was part of the reasoning behind the Bush cut.
Income Tax: This is the big fish. Most states and the federal government rely heavily on income taxes. It taxes the financial income of individuals and companies. Most systems tax income in different brackets. So a person making $30,000 a year will pay less as a % of their income than someone making $60,000 a year. This system provides governments with a relatively stable income, simply because our earnings tend to be predictable. People are taxed on gross income, while companies generally are taxed on net income (profits). The downside for individuals is they tend to overpay their taxes every year and receive a refund. Though this is often celebrated, the net effect is giving the government a free short-term loan. That money could have been used by the individual to retire debt or invest. In the US, the income tax system is regularly criticized for being too complicated.
Property Tax: Like all taxes, this one is self-explanatory. It’s a tax based on the value of an asset. The most common reference is to a tax on your home, but it also includes your car and anything else the government wants to tax. The government is generally responsible for establishing the tax value of an asset, and they have a tendency to be conservative, but not always. Interestingly, the focus is on private assets in public view, such as your home, car, or boat. But if you loan a piece of art to a museum it can now be subject to the property tax. Like the capital gains tax, this tax tends to get revenue from those that make enough to obtain assets worth taxing.
Value Added Tax: This tax is familiar to our friends in Europe. It’s more complicated than a sales tax or income tax, but potentially more appropriate. Imagine a sales tax at every point in the supply chain. Generally, each stop in the chain of a product being converted from raw materials to something worth buying, has value added to it. So in the gas industry you might have 3 stops. The first group pumps oil and sells it to the refiner – tax. The refiner converts the oil to gasoline and sells it to gas station – tax. You pump the gas and pay the station – tax. Like any system it has its holes that allow people to commit fraud, but nothing is perfect. This system is also considered the most fair, since everyone gets taxed based on the contribution they make to the economy.
However there are some other terms in taxation that you’ve probably heard about but don’t understand either what they are or why they exist.
Regressive Tax: A tax that is less strenuous on the rich as it is on the poor. Sales taxes like that used in the US and the VAT in Europe are regressive taxes. The US income tax is the opposite in that it is progressive; the more you make, the more your tax burden is.Tariff: A tax designed to discourage a behavior. It’s most often applied on imports to protect domestic industries. Russia might impose a wheat tariff so that it’s more expensive for Russians to import wheat than just buy the wheat grown in the country. Tariffs are very disruptive on free markets and pricing.
Fair Tax: A tax system that is a universal sales tax. It was proposed as a solution to the complicated tax code the US currently has. It is a regressive tax, however breaks for the poor could be made to make it work.
Tax Break: Breaks in tax liabilities designed to encourage certain behaviors. Tax breaks are given to incent you to buy green energy products, borrow to pay for college, and give banks an incentive to buy other banks. They are also used for stimulus in time of need.