Three types of taxes are progressive taxes, which collect proportionally more money from people with more money; regressive taxes, which have a higher impact on people with less money; and proportional taxes, which tax all the same in proportion to their activities. The most common forms of taxes in the United States are income tax, sales tax and property tax. Other types of tax include payroll taxes, excise taxes, estate and gift taxes and import tariffs.
Progressive Vs. Regressive Tax
A progressive tax takes a higher percentage of funds from people making more money. The federal income tax system is a progressive tax system, since people earning more money generally end up in higher tax brackets, where each additional dollar earned is taxed at a higher rate than the same dollar would be taxed if earned by someone making less overall. Many states also have progressive tax systems.
A regressive tax system is the opposite. It impacts people with lower income at a higher rate. Sales taxes are often considered to be regressive taxes in practice, since people making less money end up spending a higher percentage of income on taxable goods and services and thus spending a higher percentage of their incomes on sales taxes. Social Security taxes a steady percentage of earned income but only up to a maximum level. It's also sometimes called a regressive tax, since the more you earn above that threshold, the less you pay in total toward taxes.
The terms aren't meant to be political or value judgments, although people who politically identify as "progressive" often favor wider use of progressive taxes to place more of the costs of paying for government on wealthier taxpayers.
Proportional Tax Definition
A proportional tax, or flat tax, charges all taxpayers the same percentage of their income. Some states use flat income taxes, and the federal Medicare tax is a flat percentage of income earned.
Proponents often say proportional taxes are fairer to taxpayers and easier to compute and reason about, since less needs to be known about a taxpayers' overall situation to figure how much each person owes in tax on each dollar earned.
Critics say proportional taxes can end up effectively functioning as regressive taxes, since rich people will still have more disposable income as a percentage of salary after paying taxes and any necessary expenses.
Income, Sales and Property Tax
Three of the most common types of taxes in the U.S. are income tax, property tax and sales tax.
Income tax is assessed based on how much money you make, and includes tax on earnings from work, interest and dividends from investments and capital gains tax on selling things that have gone up in value. The federal government, most states and some local governments charge income tax on people who live or work in their jurisdictions.
Property tax is assessed on real property that you own, including standalone properties and condominiums. Some states also charge property tax on automobiles. Taxes are generally based on the assessed value of your property, linked to how much it's worth.
Sales taxes are charged proportionally to the prices of items you buy at a store. Some state and local governments charge sales tax, although many exempt or charge lower taxes on necessities such as food and medicine.
How Income Tax Works
Generally if you live and make money in the U.S., or you're a U.S. citizen living abroad, you must file a federal income tax return every year according to the progressive tax system of the U.S., which charges higher tax rates on higher incomes. If you are working in the U.S., you'll generally have money withheld from your paycheck to pay federal, state and local taxes throughout the year.
Specify your income on the form, following its instructions, along with any deductions and credits you have that can lower your taxes. Deductions reduce the amount of income you have that is taxable, while credits directly offset taxes owed.
If you owe tax when you file, you must pay it by check or direct transfer. If you have overpaid, you can get a refund or apply the difference to next year's taxes.
How Property Tax Works
Property tax is charged by state and local authorities, such as counties, cities, school districts and other special tax districts, where you own property. Property tax is sometimes referred to as an ad valorem tax, meaning that it is charged according to the value of your property, so it's often considered a proportional tax. It's the primary way most local jurisdictions fund their government operations, including schools and police.
Property is often subject to different rates depending on how it is used. Industrial and commercial properties may be taxed at a different rate than residential property. Many jurisdictions offer a homestead exemption, decreasing tax rates for people on their primary or secondary residence, and some offer tax breaks for senior citizens, disabled people and others who may struggle to pay their taxes.
Generally, a periodic property reassessment determines property value to ensure people are charged the right tax amounts. Some jurisdictions cap how much people's taxes can rise over time to prevent people from being taxed out of their homes and other properties as values rise.
How Sales Tax Works
Sales tax is charged when you buy an item in a retail store and often when you purchase something online or by mail order. Exactly what items are taxed and at what rates varies from state to state and municipality to municipality.
Some places exempt certain items from sales tax, including necessities like food and menstrual supplies. Many jurisdictions charge higher taxes on items used by tourists or considered to be luxuries, including hotel accommodations and restaurant meals. Taxes kept high and designed to discourage use of potentially dangerous goods, such as alcohol and tobacco, are often called sin taxes.
If you buy an item and aren't charged sales tax when you buy it for whatever reason, you may still be required to pay what is called "use tax" on the item when you file your state tax return. This can apply if you buy something in another state where there is no sales tax or you buy an item online aren't charged the tax.
Sales taxes are often considered regressive taxes since people with less money must spend a higher percentage of their income and net worth on goods.
Tariffs and Import Taxes
The three main types of taxes aren't the only kinds of tax. Another common type includes import tariffs, charged on goods brought into a country or jurisdiction. They can be used to raise revenue and also to encourage residents of a country to buy locally made goods that aren't subject to the tariff, thus keeping money in the economy.
Free trade advocates say tariffs make the world economy less efficient by artificially interfering with countries' abilities to sell goods they can make cheaply abroad. Like sales taxes, they can be considered regressive taxes, since they apply disproportionately to people with less money who spend a higher percentage of income and worth on purchases.
Understanding Payroll Taxes
Payroll taxes are related to income taxes. They're charged to employers based on the amount of money paid to employees. Social Security and Medicare taxes include a payroll tax portion, and some states and local agencies charge some payroll taxes as well.
Social Security tax, which cuts off at a certain level of income, is often seen as a regressive tax, while Medicare is a flat, proportional tax. Self-employed people often must pay payroll taxes on their own earnings.
Estate and Gift Taxes
In the U.S., if you give someone money or something else valuable as a gift, they do not have to pay tax on it. Instead, the giver is liable for any gift tax, although large annual and lifetime exemptions mean most gifts are in practice not subject to any tax.
Estate tax works in a similar way, with money and assets left behind when someone dies technically taxed against the dead person's estate rather than against the heirs.
- IRS: IRS Working on a New Form 1040 for 2019 Tax Season
- IRS: Credits and Deductions for Individuals
- Investopedia: Ad Valorem Tax
- Investopedia: Proportional Tax
- New York City: Assessments
- Texas Comptroller: Texas Homestead Exemption Frequently Asked Questions
- The Economist: Do Sin Taxes Work?
- Investopedia: Use Tax
- Investopedia: What are the Differences Between Regressive, Proportional, and Progressive Taxes?
- Investopedia: Tariff
- Investopedia: Payroll Tax
- FindLaw: Estate and Gift Tax: An Overview