Lesson Objectives:- Income taxes
- Payroll taxes
Your income is taxed on a tier-based system. The first few dollars of your yearly income are not even taxed. Then, the next few dollars are taxed at a certain rate. Your final dollars are taxed at the highest rate called the marginal tax rate.
This system of marginal tax rates provides the incentive to find ways to reduce taxable income. The higher the rate, the more incentive the taxpayer has.
To find ways to reduce taxable income, taxpayers look for Loopholes. A loophole is a legal method by which individuals and businesses are allowed to reduce the tax liabilities they owe to the government. An example of a common loophole might be the home mortgage interest deduction, where you can deduct your home loan's mortgage interest on your taxes.
Individuals and corporations adjust their earning and spending behavior based on the tax rate they face. They also get together and try to influence Congress to provide more loopholes in the tax law.
People who make more, pay more. Income tax is a Progressive Tax, which is a tax that rises in percentage terms as incomes rise. People paying higher taxes have incentive to find as many loopholes as they can. But, income tax is not all we pay in taxes.
There is also the federal Social Security tax we all pay into. It has a limit to it, however. If a person makes more than a certain amount, they do not pay Social Security on the amount above the cap. For example, in 2018, the "cap" was at $128,700. A nice tax loophole is that there is no Social Security tax levied on investment income. That is capital gains, rents, royalties, interest, dividends, or profits from business.
That makes Social Security a Regressive Tax, or a tax that falls in percentage terms as incomes rise.
Medicare is funded by an employer/employee tax that is currently at 2.9%. However, anyone making over $200,000 pays 3.8%. Three-quarters of taxpayers actually pay more in these payroll taxes than in income tax.
What Kind of Tax System Do We Have? As a whole, our tax system is slightly progressive, with regressive parts within it.