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Types of Taxes

Types of Taxes

Do you know what taxes employers have to pay vs employees? What about the rich vs the poor? There are many different types of taxes in existence in the United States, and they each apply to specific situations. Not everyone is going to be responsible for paying every type of tax that there is: that just wouldn't make sense. To learn the different types of taxes, who is responsible for paying them, and more, keep reading on!

Types of Taxes in Economics

When it comes to types of taxes, there are three general systems that are focused on in economics: regressive, progressive, and proportional.

Regressive taxes

Owing to the fact that it is applied to all circumstances and people, no matter who they are, a regressive tax affects low-income earners more heavily than high-income earners. While taxing everybody at an equal rate may be reasonable in some contexts, it is perceived as unfair in others. For example, lower-income households spend a greater percentage of their earnings on housing, meals, and transit. Any tax reduces their potential to pay for these necessities.

A regressive tax is one that creates a smaller burden on the rich and a greater burden on the poor.

Progressive taxes

Progressive taxes are ones that are based on the ability of the individual to pay. It has a lower rate for low-income earners than it does for higher-income earners. This is normally accomplished by categorizing taxpayers into brackets based on their wage levels. For example, the United States' tax system is regarded as progressive.

Progressive taxes are taxes that are lower for low-income taxpayers and increase as taxpayer's income increases.

Proportional taxes

A proportional tax is a type of tax in which everyone pays the exact same percentage tax, irrespective of their earnings. Lower-income, middle-income, and high-income earners all owe the same percentage tax. These taxes are also called flat taxes.

A proportional tax is a type of tax in which everyone pays the exact same percentage tax.

Imagine your government uses a proportional tax system. They decide on a 10% income tax rate and that tax rate applies to everyone. For someone who makes only $20,000 a year, they would have to give $2,000 in taxes a year. Someone who makes $200,000 on the other hand would pay $20,000. Even though the tax rate remains the exact same across the board, it's obvious that the strain on lower-income taxpayers is greater than on higher-income ones.

Example of Progressive Tax

There are a few examples of the progressive tax such as:

Capital gains tax

As far as the United States is concerned, any income under $40,000 a year pays 0% in capital gains tax. The middle bracket is from $40,000 to $445,000 which gets taxed at 15%1, and anything above that gets taxed at 20%.

Luxury sales tax

Because they are flat taxes applied to everyone, normal sales taxes might unfairly burden the poor. Since the impoverished spend a greater portion of their earnings, they pay a higher tax rate. However, a luxury sales tax is only imposed on high-priced items. Rich people can purchase products like expensive cars and designer clothes, so imposing a tax on these sorts of items ensures that sales tax strain is focused less on the poor.

Estate tax

In the United States, the estate tax is 40% on estates priced at more than $5.3 million for a single person and $10.6 million for a couple. Those with a property worth less than this amount pay $0, which implies that 99% of people don't have to pay estate taxes.1 As a result, only the rich pay it.

Different Types of Taxes

All of the taxes that you will see in this article one way or another comprise a source of the U.S. Federal Government Revenue as shown in the Figure below:

Types of Taxes, Sources of revenue for the U.S. Federal Government Chart, StudySmarterFigure 1. Sources of revenue for the U.S. Federal Government, StudySmarter Originals. Source: DataLab2

As you can see in the Figure above, income taxes represent the majority of where the U.S. Federal Government revenue comes from with social security and corporate taxes being the next largest.

Within the general category of taxes, there are two main ones: direct and indirect.

Direct taxes

Direct taxes are those that cannot be transferred and are paid directly to the government by the taxpaying individual. Depending on the kind of tax imposed, both the federal government and state governments have the opportunity to collect direct taxes.

Direct taxes are those that cannot be transferred and are paid directly to the government.

Many different taxes fall under the category of direct taxes. Some of these include:

Capital Gains Tax

Once an investment is sold and profits are made, capital gains taxes are applied. The tax is on the actual profit that was made from selling it, not how much you get for it. Not many people have capital gains taxes to pay since not everyone is involved with investing.

Corporate Tax

Corporate taxes refer to the taxes that firms have to pay on their profits. The current level of corporate income tax in the United States is 21%.

Income Tax

Income taxes are the taxes that have to be paid on the wages you make. Government income tax, for instance, is both progressive and marginal. Various tax rates for various income levels are said to be marginal. For example, those who are higher earners do pay a higher tax rate, however, that higher tax rate only applies to the funds that are within the higher bracket.

Marginal refers to the various rates of tax that are in place for the different tax brackets in place

Inheritance Tax

Inheritance tax is a type of tax paid on the benefit of inheriting land or other assets.

Indirect taxes

Indirect taxes are those that can be transferred to another individual. Examples of these include sales tax and service tax.

Indirect taxes are taxes that can be transferred to someone else.

Sales Tax

This tax is paid by a merchant or seller, who then passes the expense to buyers by imposing sales tax on products and services.

Service Tax

These are taxes that are charged for services provided to customers, like a restaurant check.

Types of Employee Taxes

Employee taxes are the federal taxes that an individual, their company, and their workers must pay. There are many kinds of employee taxes, and the main ones are the following:

Federal

Employers must hold federal taxes from their employees. The quantity withheld is decided by the form that the worker fills out when hired, when their status changes, or when they wish to adjust their withholding amount.

FICA

Employers in the United States must withhold FICA taxes to finance Medicare as well as Social Security from all workers' wages and return the employer and employee shares of the tax to the IRS.

Unemployment

Employers must pay federal unemployment tax (FUTA) in order to offer assistance to workers who have lost their jobs. This tax isn't paid for by the workers themselves. Employers make a contribution depending on their employees' gross pay, taking into account each worker and their maximum wages. In addition to this, a majority of states also require workers to partake in and pay taxes for state unemployment.

Workers' compensation

Firms must contribute to state-run programs that offer compensation to workers who become sick or injured on the job. State workers' reimbursement laws oversee these reimbursements, which are funded by employer payments to state compensation programs for workers.

Types of Corporate Tax

Legally, a corporation is a legal organization seen as separate from its owners for tax reasons and is taxed on company earnings. Corporations are divided into two categories: regular corporations, sometimes called 'C corporations' and 'S corporations'. These corporations then have specific corporate taxes that they are responsible for paying. Some of these include:

Federal income tax

A typical corporation, sometimes known as a 'C corporation' is required to submit an earnings tax return at the conclusion of the fiscal year. The corporation must disclose its income, earnings, losses, deductions, and debts. A company could be taxed anywhere from 15% to 38% depending on its taxable income. Whereas a C company is taxed first to the company and then to the shareholders who receive dividend payouts, an S corporation is taxed exclusively to the corporation's stockholders.

State tax

Corporations could be liable to state taxes on their income as well. Some states, like Nevada, do not tax the income of a corporation. There are some states that levy a fixed rate, and a majority of other states are tax based on which tax bracket the corporation fits into. Furthermore, states have the authority to collect extra taxes, like franchise taxes, which are taxes that corporations pay for being allowed to run their business at all, and also for running their business in a particular location.

Excise tax

Corporations could also be subject to federal excise taxes as well. Corporations often face excise taxes if they make or sell specific items, run specific types of enterprises, utilize specific types of machinery or facilities, or get compensation for specific services. Excise taxes are imposed by the IRS on items such as gas for vehicles and air transportation of persons or things.

Estimated tax

If a firm anticipates owing $500 or more in federal income taxes, it has to make anticipated income tax payments throughout the year. In the case that a corporation neglects to make estimated tax payments, that could result in them being penalized, but if they overpay their expected taxes, they can request a refund.

Types of Taxes - Key takeaways

  • When it comes to types of taxes, there are three general systems that are focused on in economics: regressive, progressive, and proportional.
  • A regressive tax is one that creates a smaller burden on the rich and a greater burden on the poor.
  • Progressive taxes are taxes that are lower for low-income taxpayers and increase as taxpayer's income increases.
  • A proportional tax is a type of tax in which everyone pays the exact same percentage tax.
  • Direct and indirect are the two main tax categories. Direct taxes are those that cannot be transferred and are paid directly to the government. Indirect taxes are taxes that can be transferred to someone else.

References

  1. Muresianu, Alex, The US Tax Code is Progressive, Tax Foundation, 2021
  2. DataLab, Sources of Revenue for the Federal Government , 2021, https://datalab.usaspending.gov/americas-finance-guide/revenue/categories/

Frequently Asked Questions about Types of Taxes

It's an indirect tax

Indirect vs direct

A direct tax

Regressive, progressive, and proportional

Sales tax is regressive due to the fact that people who have a lower income end up paying a larger percentage of their earnings in the form of sales tax, as compared to those with higher incomes

Final Types of Taxes Quiz

Question

What are the three main types of taxes focused on in the US?

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Answer

Regressive, progressive, and proportional

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Question

What's a regressive tax?

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Answer

A regressive tax is one that creates a smaller burden on the rich and a greater burden on the poor. 

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Question

What's a progressive tax?

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Answer

Progressive taxes are taxes that are lower for low-income taxpayers and increase as income increases.

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Question

What's a proportional tax?

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Answer

A proportional tax is a type of tax in which everyone pays the exact same percentage of tax.

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Question

What's another name for proportional taxes?

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Answer

Flat taxes

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Question

What's an advantage of a luxury sales tax?

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Answer

Luxury sales tax is only imposed on high-priced items. Rich people can purchase products like expensive cars and designer clothes, so imposing a tax on these sorts of items ensures that sales tax strain is focused less on the poor.

Show question

Question

Direct taxes are those that cannot be transferred and are paid directly to the government.

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Answer

True

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Question

What is meant by the term marginal in reference to taxes?

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Answer

Marginal refers to the various rates of tax that are in place for the different tax brackets in place.

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Question

Indirect taxes are taxes that can be transferred to someone else.


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Answer

True

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Question

Name at least two types of employee taxes

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Answer

Federal, FICA, Unemployment, Workers' compensation

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Question

What type of tax is an income tax?

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Answer

A direct tax

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Question

Is a sales tax, regressive, progressive, or proportional?

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Answer

Regressive because it disproportionately affects lower-income people.

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Question

Employers must pay federal unemployment tax (FUTA) in order to offer assistance to workers who have lost their jobs. 


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Answer

True

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Question

Legally, a corporation is a legal organization seen as ______ from its owners for tax reasons and is taxed on company earnings


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Answer

separate

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Question

What are the two types of corporations?

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Answer

Regular or "C" corporations

S corporations

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