Income tax
Definition
An income tax is a tax that is levied on, and is generally an increasing function of, income. Income taxes are levied on persons (individuals or households). There is a related notion of income tax for corporations, which is discussed on the separate corporate tax page.
Mechanics
Burden of remitting the tax
- Income taxes are usually paid by the individual or household as part of an annual process of filing a tax return. The tax return is a statement of the income over the tax year as well as the calculation of tax based on the income. A tax return includes filled versions of forms created by the taxing authority.
- Many payers of income, including employers paying wage income, as well as banks offering interest income, may be required to deduct taxes from the employee's income and send it to the taxing authority. These deducted taxes are called tax withholdings, and represent an advance payment of the eventual tax obligation of the individual or household. Tax withholdings help the tax authority obtain a steady stream of income tax revenue throughout the year, increase tax compliance, and reduce the visibility of taxation to individuals and households.
Structure of tax rates
Income tax rates are quoted inclusively. For instance, an income tax rate of 10% means that the taxpaper pays 10% of income, leaving the taxpayer with the remaining 90%. This is in contrast with sales taxes, which are quoted exclusively.
Structure and applicability
= Generally progressive structure
In most jurisdictions, the income tax formula is progressive: the higher the income, the higher the average tax rate. Marginal income tax rates are generally constant over income ranges and jump discretely. These income ranges are sometimes called tax brackets or tax slabs. The lowest marginal tax rate is generally zero (though this might be operationalized in the form of a "standard deduction" or "personal exemption" on taxable income rather than a 0% marginal tax rate) and the highest marginal tax rate can vary from 1% to 90% depending on jurisdiction.
Some jurisdictions have a flat income tax rate, though even these jurisdictions support some basic exemption, so they effectively have a two-tiered tax rate: 0% for the exempted income, and then a fixed rate.
Income taxes are almost never regressive; however, social security taxes, which are in many ways similar to income taxes, may be regressive or even capped.
Sensitivity to distribution across persons and time periods
Since income tax rates are progressive and not flat, the total income tax burden over a multi-year time period cannot be determined by looking at the total income over the time period. Rather, the distribution of income across the multi-year time period determines the amount of tax. In general, assuming no significant changes to tax rates or tax brackets between the years, the tax is least when the income is evenly distributed across the time periods.
Similarly, the total income tax burden across a set of people is not determined purely by the total income of those people, but also by the distribution, The closer to even the distribution of income, the lower the total income tax.
Individual versus household
Tax treatment generally provides lower tax rates on the same income to a married couple filing jointly than to an individual, but the tax rates are higher than if they both reported their separate incomes as individuals. Households with children may have to pay less in taxes for each child, up to some limit.
Deductions
Taxes in general have three justifications: revenue justification, incentive justification, and group/class warfare justification. Tax laws include a large number of deductions for politically or socially favored categories of expenses, such as charitable donations or healthcare payments. This ties with the incentive justification, as the tax law wants to incentivize people to donate to charity and take care of their health.
Deductions generally add to the complexity of the tax code, significantly adding to the overhead of tax preparation.