The popular saying is that “only two things are certain in life; death and taxes.” This is true and both can be very painful. There has been much debate in the U.S. in recent years over which tax system would be best for the citizens and the economy of our country.
Currently, the national, state, and local governments in the U.S. rely on a smorgasbord of taxes. Two broad categories of taxes are business/corporate and individual. All are “direct” taxes because they are linked with income and profits. The taxes come in a number of forms, but there are actually three types of direct taxation: progressive, proportional and regressive.
Progressive taxation bases the tax rate on income. The rate of taxation increases with income at least in individual income tax. This is the type of income tax currently used in the United States. For example, in 2012 a single person making $50,000 was in the 25 percent tax bracket. The first $8,700 of income was taxed at 10 percent, and income from $8,700 to $35,350 was taxed at 15 percent. The final portion from $35,350 to $50,000 was taxed at the 25 percent rate.
Business tax rates vary with income such as in 2012 when a business making up to $50,000 was taxed at the 15 percent rate. Tax rates reached as high as 39 percent for businesses making from $100,000 to $335,000 in 2012. Income that exceeds $335,000 decline to the point that income exceeding $18,333,333 is taxed at 35 percent.
Proportional taxes apply the same tax rate regardless of income. For example, proponents of the flat tax argue that the proportional tax is most fair because everyone will pay the same percentage of income. For example, with a flat tax rate of 15 percent, everyone would pay 15 percent income tax.
A similar approach could be adapted for business and corporate taxes though the factoring in the “costs of doing business” could be troublesome in determining income. Another component of a flat tax that could prove to be troublesome is the tax rate only applies to earned income so income earned from dividends and investments are exempt from taxation. This is because these monies have already been taxed.
A regressive tax is similar to a proportional tax in that the tax rate is a net decrease for those of higher incomes. A simple example is sales taxes. Everyone pays the same sales tax rate on the purchase of goods. The effect of paying sales taxes will be more significant for lower income by taking a higher percentage of income than for consumers than higher income consumers.
A common motivation for taxpayers is to look for ways to lower their taxes. Each type of tax offers ways for doing this. Progressive taxes can be lowered by lowering personal or business income or by increasing deductions.
Proportional taxes can only be lowered by lowering the percentage of taxation or lowering personal income. Most versions of proportional income taxes like the flat tax do not allow for deductions, tax credit or exemptions. Proponents often use the exclusion of deductions as a way of eliminating the government’s bias in promoting certain behaviors. The one caveat would be how income was treated that was diverted to investments since dividends would be exempt from the flat tax.
Regressive taxes are lowered by reducing purchases, or buy making purchases from tax-free vendors. Online shopping has been tax-free until recently when some states took steps to tax online purchases. Garage sales and purchases of used goods are tax-free.