U.S. Supreme Court Justice Oliver Wendell Holmes once said, “Taxes are the price we pay for a civilized society.” One can argue about the extent and quality of the civilization that we receive for our tax dollars, but it can’t be denied that we do pay a lot for it.
In fact, when every tax is tallied – federal, state and local income tax (corporate and individual); property tax; Social Security tax; sales tax; excise tax; and others – Americans spend 29.2 percent of our income in taxes each year.
There are many different kinds of taxes, most of which fall into a few basic categories: taxes on income, taxes on property, and taxes on goods and services.
Taxes on Income
The federal government, 43 states and many local municipalities levy income taxes on personal and business revenue and interest income. In most cases, income tax brackets are progressive, meaning that the greater the income, the higher the rate of taxation. Federal rates for the 2013 tax year range from 10 to 39.6 percent. State and city rates are generally much lower. In addition, many systems allow individuals to trim their tax bill with various credits, deductions and allowances. Businesses pay taxes on their net income.
In addition to federal income taxes, the U.S. government also mandates that employers subtract payroll taxes from their workers’ paychecks each pay period, and then match the sums deducted. These payments are called FICA taxes because they are authorized by the Federal Insurance Contribution Act. Total FICA taxes on individual workers are 7.65 percent of income; 6.2 percent goes to fund the nation’s Social Security system, while 1.45 percent goes to Medicare. Self-employed individuals are liable for the entire 15.3 percent, although one half of that amount can be taken as an above-the-line business deduction on a person’s income tax return.
Capital gains taxes are those paid on any profits made from the sale of an asset and are usually applied to stock and bond transactions. The capital gains tax rate has recently been raised from 15 to 20 percent. Profits made from the sale of real estate are also subject to a capital gains tax. Single homeowners may exclude up to $250,000 of capital gain on the sale of a home, as long as the home was a principal residence for at least two of the five years before the sale; married couples filing jointly can exclude up to $500,000.
Estate taxes are imposed on the transfer of property upon the death of the owner. They were created to prevent the perpetuation of tax-free wealth within the country’s most affluent families. Since the tax exempts the first $5.43 million of an estate’s worth, estate taxes only affects about 1 percent of the citizenry. The maximum top estate tax rate is 40 percent. Many states also impose their own estate tax, sometimes known as an inheritance tax. Opponents of these types of taxes believe that they are an unfair confiscation of wealth passed on to an heir and call them “death taxes.” A tax related to the estate tax, and assessed in a similar manner, is the gift tax, levied on a transfer of wealth during a person’s lifetime. The first $14,000 of a gift is excluded from the tax.
Taxes on Property
Property tax, sometimes known as an ad valorem tax, is imposed on the value of real estate or other personal property. Property taxes are usually imposed by local governments and charged on a recurring basis. For example, homeowners will generally pay their real estate taxes either once a year or as a monthly fee as part of their mortgage payments.
Real estate taxes are often subject to fluctuation based upon a jurisdiction’s assessment of the worth of a property based on its condition, location and market value, and/or changes to the amounts apportioned to various recipients of the tax. For example, if residents of a community have voted to increase the millage rate (the amount per $1,000 that is used to calculate taxes) for a school system, homeowners could see an increase in the tax levied on their properties. Conversely, if property values have fallen due to adverse economic circumstances, home taxes may decrease.
Other items that may be subject to a property tax are automobiles, boats, recreational vehicles and airplanes. Some states also tax other types of business property such as factories, wharves, etc.
Taxes on Goods and Services
The sales tax is most often used as a method for states and local governments to raise revenue. Purchases made at the retail level are assessed a percentage of the sales price of a particular item. Rates vary between jurisdictions and the type of item bought. For example, a pair of shoes may be taxed at one rate, restaurant food at another, while some items, like staple commodities bought at a grocery store, may not be taxed at all. Also, the same shoes may be taxed at a different rate if sold in a different state or county.
Some believe that sales taxes are the most equitable form of taxation, since they are essentially voluntary and they extract more money from those who consume more. Others believe that they are the most regressive form of taxation, since poorer people wind up paying a larger portion of their income in sales taxes than wealthier individuals do.
Excise taxes are based on the quantity of an item and not on its value. For example, the federal government imposes an excise tax of 18.4 cents on every gallon of gas purchased, regardless of the price charged by the seller. States often add an additional excise tax on each gallon of fuel.
User fees are taxes that are assessed on a wide variety of services, including airline tickets, rental cars, toll roads, utilities, hotel rooms, licenses, financial transactions and many others. Depending upon where someone lives, a cellphone, for example, may have as many as six separate user taxes, running up the monthly bill by as much as 20 percent.
So-called sin taxes are imposed on items like cigarettes and alcohol. Luxury taxes are imposed on certain items, such as expensive cars or jewelry.