Taxes are an important part of any government's revenue system. There are three main types of taxes: progressive, regressive, and fixed. Understanding the differences between these tax systems can help you better understand how taxes work and how they affect you. A progressive tax is one that has a greater financial impact on people with higher incomes than on people with lower incomes.
The tax rate and tax liability increase in line with the taxpayer's income. Examples of progressive taxes in the United States include investment income and wealth taxes. A regressive tax is one that has a greater impact on low-income people than on wealthy people. This is because the government evaluates taxes as a percentage of the value of the asset a taxpayer buys or owns.
Regressive taxes include property taxes, sales taxes on goods, and excise taxes on consumables such as gasoline or airline tickets. Sin taxes, a subset of excise taxes, are imposed on products or activities that are considered unhealthy or have a negative effect on society, such as cigarettes, gambling, and alcohol. Critics of sin taxes argue that they disproportionately affect those who are less well-off. A fixed tax, also known as a proportional tax, affects people with low, middle, and high incomes relatively equally.
Everyone pays the same tax rate regardless of income. Social Security can be considered a regressive tax because everyone pays the same rate, at least up to the salary base. Other examples of proportional taxes include per capita taxes, gross income taxes, and occupational taxes. Proponents of proportional taxes believe that they stimulate the economy by encouraging people to work more because there is no tax penalty for earning more.
The federal income tax in the United States is a progressive tax system. Its list of marginal tax rates imposes a higher income tax rate on people with higher incomes and a lower tax rate on people with lower incomes. The percentage rate increases periodically as taxable income increases. Every dollar a person earns places them in a category or bracket, resulting in a higher tax rate once the dollar amount reaches a new threshold.
Part of what makes the federal progressive income tax system in the United States is the standard deduction that allows people to avoid paying taxes on the first part of their income each year. The standard deduction amount changes from year to year to keep up with inflation. In addition to income taxes, there are federal taxes that fund Social Security and Medicare, which together are FICA (Federal Insurance Contributions Act) taxes. These can be considered regressive because everyone pays the same rate regardless of their income level. Understanding different types of tax rates can help you make informed decisions about your finances and how you pay your taxes. Knowing how each type of tax works can help you understand how much money you owe and how much money you can save.