income tax

income tax

income tax, assessment levied upon individual or corporate incomes. Although personal incomes were occasionally taxed in medieval Italian cities, the income tax is essentially a modern form of taxation. The first important income tax was levied in Great Britain from 1799 to 1816 in order to raise funds for the Napoleonic Wars. After several other temporary income taxes, Britain adopted a permanent one in 1874. The first income tax in the United States was imposed in 1864, during the Civil War, but was discontinued in 1872. Various European countries, as well as Australia, New Zealand, and Japan, adopted regular income taxes during the latter half of the 19th cent.

In the United States, the income tax law of 1894 was declared unconstitutional on the grounds that it was a direct tax not apportioned according to state population. The adoption of the Sixteenth Amendment (1913) permitted both the corporate and individual income tax to become a lawful element in the federal tax structure. Since then they have been a major source of revenue for the federal government, yielding as much as 85% of all its receipts in some years. Income taxes had been levied sporadically by various states since 1789; since 1919 most states have adopted the tax. The first major American city to impose a tax on incomes was Philadelphia (1939).

In general, personal incomes below a certain amount are exempted from the individual income tax, the amount varying for single and for married persons with or without dependents. The tax is applied to the net income above such exemptions, and the rate becomes progressively higher for larger incomes. From the mid-1960s until 1982 the tax rate ranged from about 15% for the lowest brackets to about 70% for the highest, with a similar structure for corporate income taxes. In 1982, Congress passed President Reagan's plan to cut the highest rate on personal income tax from 70% to 50% and the capital gains tax from 50% to 20%. The Tax Reform Act of 1986 further lowered the maximum marginal tax rates from 50% to 28%, the lowest since the 1920s. A top rate of 31% was added in 1991, and additional rates of 36% and 39.6% for the wealthiest individuals were approved in 1993. Under changes enacted in 1997, the tax rate on most long-term capital gains is 20%—10% for people in the 15% tax bracket; the rate is slightly lower for investments held at least five years. Further changes enacted under President George W. Bush in 2001 reduced the rate in the lowest income-tax bracket to 10% (for the first $6,000 of income only) and called for the tax rates of all brackets above the 15% rate to be reduced to 25%, 28%, 33%, and 35% by 2006. These rates and all other provisions of the act will be rescinded in 2011, however, unless continued by passage of another law. The top corporate tax rate is 39%, although the highest income-bracket tax rate is 35%. In many states and cities, lowered federal income taxes have been offset by higher state and local income and property taxes. In the 1980s and 90s, the call for a "flat tax"—a single tax rate (around 17%-20%) for individuals and businesses—was a recurring campaign issue among American conservatives. Such an income tax has been adopted by a number of E European countries.

See D. J. Gaffney and D. H. Skadden, Principles of Federal Income Taxation (1982); J. Creedy, The Dynamics of Income Distribution (1985); M. Levi, Of Rule and Revenue (1988).

An income tax is a tax levied on the financial income of persons, corporations, or other legal entities. Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate tax, corporate income tax, or profit tax. Individual income taxes often tax the total income of the individual (with some deductions permitted), while corporate income taxes often tax net income (the difference between gross receipts, expenses, and additional write-offs).

Principles

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 flat. A progressive tax taxes differentially based on how much has been earned. For example, the first $10,000 in earnings may be taxed at 5%, the next $10,000 at 10%, and any more income at 20%. Alternatively, a flat tax taxes all earnings at the same rate. A regressive income tax may tax 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. However, the idea of a progressive income tax has garnered support from economists and political scientists of many different ideologies, from Adam Smith in The Wealth of Nations to Karl Marx in ''The Communist Manifesto.

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, for taxpayers who have not paid enough during the tax year; and tax refunds from the government for those who have overpaid. Income tax systems will 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.

History

The concept of taxing income is a modern innovation and presupposes several things: a money economy, reasonably accurate accounts, a common understanding of receipts, expenses and profits, and an orderly society with reliable records. For most of the history of civilization, these preconditions did not exist, and taxes were based on other factors. Taxes on wealth, social position, and ownership of the means of production (typically land and slaves) were all common. Practices such as tithing, or an offering of firstfruits, existed from ancient times, and can be regarded as a precursor of the income tax, but they lacked precision and certainly were not based on a concept of net increase.

In the year 10, Emperor Wang Mang of China instituted an unprecedented tax -- the income tax -- at the rate of 10 percent of profits, for professionals and skilled labor. (Previously, all Chinese taxes were either head tax or property tax.) A true income tax was first implemented in Britain by William Pitt the Younger in his budget of December 1798 to pay for weapons and equipment in preparation for the Napoleonic wars. Pitt's new graduated income tax began at a levy of 2d in the pound (0.8333%) on incomes over £60 and increased up to a maximum of 2s (10%) on incomes of over £200. Pitt hoped that the new income tax would raise £10 million but actual receipts for 1799 totalled just over £6 million (see UK income tax history for more information). The first United States income tax was imposed in July 1861, 3% of all incomes over 600 dollars (later rescinded in 1872).

Types

Personal

A personal or individual income tax is levied on the total income of the individual (with some deductions permitted). It 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, for taxpayers who have not paid enough during the tax year; and tax refunds from the government for those who have overpaid. Income tax systems will 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.

Corporate

Corporate tax refers to a direct tax levied by various jurisdictions on the profits made by companies or associations and often includes capital gains of a company. Earnings are generally considered gross revenue less expenses. Corporate expenses that relate to capital expenditures are usually deducted in full (for example, trucks are fully deductible in the Canadian tax system, while a corporate sports car is only partly deductible). They are often deducted over the useful life of the asset purchase. Notably, accounting rules about deductible expenses and tax rules about deductible expense will differ at times, giving rise to book-tax differences. If the book-tax difference is carried over more than a year, it is referred to as a temporary difference, which then creates deferred tax assets and liabilities for the corporation, which are carried on the balance sheet.

See also: Excess profits tax, Windfall profits tax

Payroll

A payroll tax generally refers to two kinds of taxes. Taxes which employers are required to withhold from employees' pay, also known as withholding, Pay-As-You-Earn (PAYE) or Pay-As-You-Go (PAYG) tax. These withholdings contribute to repayment of an employee's personal income tax obligation; if the payments exceed this obligation, the employee may be eligible for a tax refund or carryforward to future periods.

Other group of payroll taxes are paid from the employer's own funds, either as a fixed charge per employee or as a percentage of each employee's pay. Payroll taxes often cover government social insurance programs such as social security, health care, unemployment, and disability. These payments do not count towards income taxes of employees and employers, but are normally deductible by the employers.

Inheritance

The inheritance tax, estate tax and death duty are the names given to various taxes which arise on the death of an individual. In international tax law, there is a distinction between an estate tax and an inheritance tax: the former taxes the personal representatives of the deceased, while the latter taxes the beneficiaries of the estate. However this distinction is not always respected. For example, the "inheritance tax" in the UK is a tax on personal representatives, and is therefore, strictly speaking, an estate tax.

Capital gains tax

A capital gains tax is the tax levied on the profit released upon the sale of a capital asset. In many cases, the amount of a capital gain is treated as income and subject to the marginal rate of income tax. However, in an inflationary environment, capital gains may be to some extent illusory: if prices in general have doubled in five years, then selling an asset for twice the price it was purchased for five years earlier represents no gain at all. Partly to compensate for such changes in the value of money over time, some jurisdictions, such as the United States, give a favorable capital gains tax rate based on the length of holding. European jurisdictions have a similar rate reduction to nil on certain property transactions that qualify for the participation exemption. In Canada, 50% of the gain is taxable income. In India, Short Term Capital Gains Tax (arising before 1 year) is 10% [15 % from F.Y 2008-09 as per Finance Act 2008] flat rate of the gains and Long Term Capital Gains Tax is nil for stocks & mutual fund units held 1 year or more, provided the sale of shares involved payment of Securities Transaction Tax and 20% for any other assets held 3 years or more. F.A.Q on Capital Gains Tax in India

Around the world

Income taxes are used in most countries around the world. The tax systems vary greatly and can be progressive, proportional, or regressive, depending on the type of tax. Comparison of tax rates around the world is a difficult and somewhat subjective enterprise. Tax laws in most countries are extremely complex, and tax burden falls differently on different groups in each country and sub-national unit. Of course, services provided by governments in return for taxation also vary, making comparisons all the more difficult.

Critique

Critics of income tax systems have argued that they can be extremely complex, requiring detailed record-keeping, lengthy instructions, and complicated schedules, worksheets, and forms. Critics further claim that income tax systems can penalize work, discourage saving and investment, and hinder the competitiveness of business. Income taxes are 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). Taxation 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. The principles of an income tax are also argued by critics. 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."

See also

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