14-1: How Taxes Work

NOTES

Learning Target

• 1. I will demonstrate my understanding of the different types of taxes and what tax revenue is used for.

Government Revenue

•Tax: a mandatory payment to a local, state, or national government

•Revenue: government income from tax and non-tax sources

Principles of Taxation

•Benefits-received principle: people who benefit from public goods should pay for them in proportion to the amount of benefits received

•Example: using a gas tax to pay for roadimprovements

Principles of Taxation

•Ability-to-pay principle:people should be taxed on their ability to pay

•People with higher incomes should pay more taxes than those with lower incomes

Tax Bases

•Tax base: the thing being taxed: personal income, a good, or property

•Tax rate: the percentage of income that is paid in the form of a tax

Tax Structures

•Proportional tax: percentage of income paid in taxes remains the same for all income levels; it is a flat tax

•For example, if the tax rate is 10%, all taxpayers pay 10% of their income

•This taxes and poor and rich at the same amount

Tax Structures

•Progressive tax: percentage of income paid in taxes increases as income increases

•Example: federal income tax

•Places a higher tax burden on the wealthy compared to the poor

Tax Structures

•Regressive tax: percentage of income paid in taxes decreases as income increases

•Hurts lower income earners

•Examples: sales tax and property tax

Types of Taxes

• Individual income tax: a tax on an individual’s income from all sources

• Includes wages, interest, and dividends

•This information is detailed in a W-2 Wage and Tax Statement

Types of Taxes

•Corporate income tax: a tax based on a corporation’s profits

•Sales tax: a tax on the value of a good or service at the time of sale

•Property tax: a tax on the value of an individual’s or business’s assets (generally real estate)

Impact of Taxes on the Economy

•A tax on a good or service increases the cost of production

•Think back to supply and demand: taxes decreasesupply of a good and increase equilibrium price

•Tax incentive: taxes are used to influence economicbehavior

Impact of Taxes on the Economy

•Tax credits (or rebates) encourage behavior good for society and the economy

•A business may receive a tax credit for relocating to Detroit, for example, for a period of 5 years

•Sin taxes are imposed on unhealthy, damaging products, and activities such as cigarettes, alcohol, and gambling

14-2: Federal TaxesNOTES

Individual Income Tax

•The largest source of revenue for the federal government is the individual income tax

•This makes up nearly one half of the government’s revenue

•Federal income tax is a progressive tax

Individual Income Tax

• Withholding: taxes taken out of a worker’s paycheck taken by the employer

•This is based on the estimate of what you will owe in taxes

•A W-4 form allows employers to determine what amount of income tax they should deduct from each employee’s paycheck based on that person’s situation, such as whether he/she is married or single, etc.

Individual Income Tax

•Taxable income: a person’s gross (total) income less exemptions and deductions

•Gross income includes earned income:salaries, wages, tips, and commission

•It also includes interest earned from savings accounts or dividends from stock

Individual Income Tax

•Tax deductions are amounts that you can subtract from your gross income

•Things such as mortgage interest and charitable donations

•Tax credits can be subtracted from your income tax as well for things such as higher education and child care

Individual Income Tax

•Payroll tax: a tax on wages a company pays its workers

•Examples: Social Security and Medicare

Individual Income Tax

•FICA=Federal Insurance Contributions Act

•FICA is a U.S. payroll tax used to fund Social Security and Medicare

•Social Security: program to aid older citizens who have retired, children who have lost a parent, and the disabled

•6.2% of your income•After one makes $118,500 in a year he or she no longer pays the Social Security potion of the tax

Individual Income Tax

•Medicare: national health insurance program for those over 65

•1.45% of your income (up to a certain level)

•Both Social Security and Medicare taxes are paid by workers and employers (7.65% total for each)

How much did John pay in FICA? What about Medicare?

Individual Income Tax

•Tax returns: forms used to report income and taxes owed to the government

• If too much is withheld, the taxpayer gets a refund; if not enough is withheld, a taxpayer must pay the rest

Other Taxes

•Estate tax: a tax on property transferred to others after the death of the owner

•Gift tax: a tax on money or property that a livingperson gives to another

•A person can give up to $14,000 a year to multiple people in the form of a gift without having to pay taxes on it

Other Taxes

•Excise tax: a tax on the sale of a specific product (gas)

•Unemployment tax: a tax collected from employersand allocated to state and agencies to fund unemployment compensation

14-4 Notes: State Taxes and Spending

NOTES

State Revenues

•States do get some money from the federal government but they also raise funds through sales taxes and state income taxes

•A sales tax is placed on most goods and services sold in a state

•All states except Alaska, Florida, Nevada, Texas, Washington, and Wyoming have a state sales tax

State Revenues

•States also place excise taxes on goods such as alcohol, cigarettes, gas, and diesel fuel

•Most states also levy taxes on individual and corporate income

•The tax on individual income tends to be progressive

•The tax on corporate income tends to be flat

State Revenues

•States may also raise money based on property taxes

•States may also have hospitalitytaxes on hotels as well as tax gambling

State Budgets and Spending

•States are required to have a balanced budget: all government revenue has to equal government spending

State Budgets and Spending

•States have two types of budgets

•An operating budget which plans for day-to-day expenses such as salaries of employees and supplies necessary to run the government

•Subject to a balanced budget

State Budgets and Spending

•A capital budget, which plans for major expenses or investments (construction, parks, etc)

•These expenses tend to be met by long-term borrowing or the sale of bonds

•Not subject to a balanced budget

State Budgets and Spending

•Education is one of a state’s major expenses

•This includes public schools, colleges, and universities

•Education spending is approximately 30% of a state’s budget