TAXATION – INCOME TAX
August 10, 2009
A fee charged (levied) by a government on a product, income, or activity. If tax is levied directly on personal or corporate income, then it is a Direct Tax. If tax is levied on the price of a good or service, then it is called an Indirect Tax. The purpose of taxation is to finance government expenditure.
One of the most important uses of taxes is to finance public goods and services, such as street lighting and street cleaning. Since public goods and services do not allow a non-payer to be excluded, or allow exclusion by a consumer, there cannot be a market in the good or service, and so they need to be provided by the government or a quasi-government agency, which tend to finance themselves largely through taxes.
An Income tax is a tax levied on the financial income of persons, corporations, or other legal entities. Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive.
When the tax is levied on the income of companies, it is often called a corporate tax, corporate income tax, or profit tax. Individual income taxes often tax the total income of the individual (with some deductions permitted), while corporate income taxes often tax net income (the difference between gross receipts, expenses, and additional write-offs).
INCOME TAX PRINCIPLES
The tax net refers to the types of payment that are taxed, which included personal earnings (wages), capital gains, and business income. The rates for different types of income may vary and some may not be taxed at all.
Capital gains may be taxed when realized (e.g. when shares are sold) or when incurred (e.g. when shares appreciate in value).
Business income may only be taxed if it is significant or based on the manner in which it is paid. Some types of income, such as interest on bank savings, may be considered as personal earnings or as a realized property gain.
Personal earnings may be strictly defined where labor, skill, or investment is required; in others, and they may be defined broadly to include windfalls (e.g. gambling wins).
Tax rates may be progressive, regressive, or flat. A progressive tax taxes differentially based on how much has been earned. For example, the first $10,000 in earnings may be taxed at 5%, the next $10,000 at 10%, and any more income at 20%. Alternatively, a flat tax taxes all earnings at the same rate.
A regressive income tax may tax income up to a certain amount, such as taxing only the first $90,000 earned. A tax system may use different taxation methods for different types of income. However, the idea of a progressive income tax has garnered support from economists and political scientists of many different ideologies, from Adam Smith in The Wealth of Nations to Karl Marx in The Communist Manifesto.
Personal income tax is often collected on a pay-as-you-earn basis, with small corrections made soon after the end of the tax year. These corrections take one of two forms: payments to the government, for taxpayers who have not paid enough during the tax year; and tax refunds from the government for those who have overpaid. Income tax systems will often have deductions available that lessen the total tax liability by reducing total taxable income. They may allow losses from one type of income to be counted against another.
For example, a loss on the stock market may be deducted against taxes paid on wages. Other tax systems may isolate the loss, such that business losses can only be deducted against business tax by carrying forward the loss to later tax years.
The concept of taxing income is a modern innovation and presupposes several things:
A money economy
Reasonably accurate accounts
A common understanding of receipts
Expenses and profits
And an orderly society with reliable records
For most of the history of civilization, these preconditions did not exist, and taxes were based on other factors. Taxes on wealth, social position, and ownership of the means of production (typically land and slaves) were all common. Practices such as tithing, or an offering of firstfruits, existed from ancient times, and can be regarded as a precursor of the income tax, but they lacked precision and certainly were not based on a concept of net increase.
In the year 10, Emperor Wang Mang of China instituted an unprecedented tax – the income tax at the rate of 10 percent of profits, for professionals and skilled labor. (Previously, all Chinese taxes were either head tax or property tax.)
A true income tax was first implemented in Britain by William Pitt the Younger in his budget of December 1798 to pay for weapons and equipment in preparation for the Napoleonic wars. Pitt’s new graduated income tax began at a levy of 2d in the pound (0.8333%) on incomes over ￂﾣ60 and increased up to a maximum of 2s (10%) on incomes of over ￂﾣ200. Pitt hoped that the new income tax would raise ￂﾣ10 million but actual receipts for 1799 totaled just over ￂﾣ6 million. The first United States income tax was imposed in July 1861, 3% of all incomes over 600 dollars (later rescinded in 1872).