It is so important to understand the ins-and-outs of tax codes. The tax code for The United States is known as a Progressive Tax Code.
This means you’re taxed on the money you make at a certain rate based on the amount of money you make. Let’s talk about income tax.
Income Tax is the money you make from a job (or another source of income ie: rental property, self-employment, etc.), and give to Uncle Sam.
Did you know income tax is the largest source of revenue for The United States Government? Not surprisingly, this makes income tax pretty controversial.
There are many opinions on income tax being too high or too low, on whether we’re being unfairly taxed on things like alcohol, gas, tobacco, food…
Of course, when it’s all said and done the items we are being taxed on are supposed to go toward providing for the public. For example, new roads, first responders, schools and so much more.
Are you ready to hear about why it’s so controversial?
Have you ever heard of “pork barrel?”
Chances are, it sounds familiar. That’s because it happens quite frequently.
Pork barrel is essentially a way for legislators to slip funding from a project into a budget benefitting their own district.
For example, let’s say they want to do research on a tree. Obviously, this doesn’t contribute to helping our school systems or ensuring our first responders get proper pay.
Seems a little shady, right?
Now, back to progressive tax. We have used progressive tax code since the 1860’s. So, this practice has been in place for quite some time.
Let’s dive a little deeper into the three ways you can be taxed:
- Progressive Tax – This is when people who make more money are taxed at a higher rate than those who make less money. Simple enough, right?
- Regressive Tax – This is the opposite of progressive tax. It means people who make less money are taxed at a proportionally higher rate than those who make more money. For example, someone making $100,000 a year would owe a smaller percentage of their income in taxes than someone making $10,000 a year.
- Flat Tax – This imposes the same tax proportion on everyone. Meaning, regardless of if you make $100,000 a year or $10,000 a year you would pay the same percentage of tax. So, if that percentage was 10%, the $100,000 earner would pay $10,000 and the $10,000 earner would pay $1,000.
The flat tax typically gets shot down due to it being unfair. Someone making $10 million a year would be able to pay more than someone who makes $10,000 a year.
We use this progressive tax rate for a couple reasons.
One, it’s traditional. Remember earlier when I told you we’ve been using it for 160 years?
Two, it ultimately increases the government revenue that the IRS is able to collapse. There’s this idea that those who are wealthier are able to give more therefore creating more public services and (in theory) this creates a better life for everyone.
Third, the burden is less on those who make less which creates this (again, theoretical) scenario where they’re able to live a better life because they won’t have to pay as much in taxes.
Consider this article the most basic of the basics for how our tax system works. Take this information into your business, take it to your clients. Be knowledgeable about where your money goes, and why.