Income Tax - Principles of Taxes

Principles of Taxes

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 (similar to wages) or as a realized property gain (similar to selling shares). In some tax systems, personal earnings may be strictly defined where labor, skill, or investment is required (e.g. wages); in others, they may be defined broadly to include windfalls (e.g. gambling wins).

Tax rates may be progressive, regressive, or proportional. A progressive tax applies progressively higher tax rates as earnings reach higher levels. For example, the first $10,000 in earnings may be taxed at 7%, the next $10,000 at 10%, and any more income at 30%. Alternatively, a proportional tax takes all earnings at the same rate. A regressive income tax may apply to 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.

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 by taxpayers who did not pay enough during the tax year; and tax refunds from the government to those who overpaid. Income tax systems 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 idea of a progressive tax has garnered support from macro economists and political scientists of many different ideologies - ranging from Adam Smith to Karl Marx, although there are differences of opinion about the optimal level of progressivity. Some economists trace the origin of modern progressive taxation to Adam Smith, who wrote in The Wealth of Nations:

The necessaries of life occasion the great expense of the poor. They find it difficult to get food, and the greater part of their little revenue is spent in getting it. The luxuries and vanities of life occasion the principal expense of the rich, and a magnificent house embellishes and sets off to the best advantage all the other luxuries and vanities which they possess. A tax upon house-rents, therefore, would in general fall heaviest upon the rich; and in this sort of inequality there would not, perhaps, be anything very unreasonable. It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion.

Income taxes are used in most countries around the world, but are not without criticism. Frank Chodorov wrote "... you come up with the fact that it gives the government a prior lien on all the property produced by its subjects." The government "unashamedly proclaims the doctrine of collectivized wealth. ... That which it does not take is a concession." Some have argued that the economic effects of an income tax system penalize work, discourage saving and investing, and hinder the competitiveness of business and economic growth. Income taxes are also not border-adjustable; meaning the tax component embedded into products via taxes imposed on companies cannot be removed when exported to a foreign country (see Effect of taxes and subsidies on price). Alternate tax systems such as a national sales tax or value added tax remove the tax component when goods are exported and apply the tax component on imports.