U.S. Tax System Overview

Overview of the U.S. Tax System

• The Sixteenth Amendment in 1913 established the authority for U.S. Federal Income Tax.

Tax Equity

• Equity means taxpayers should pay an amount of tax that fairly corresponds to their income.
• Horizontal equity means taxpayers with the same incomes should pay the same amount of tax.
• Vertical equity means taxpayers with different incomes should pay different amounts of tax.

Tax Calculations

• Tax base refers to what is being taxed.
• Tax rate is the percentage applied to the tax base to determine the tax owed.
• Tax liability is the amount of tax that is owed.

Tax Rate Types

• Progressive tax rate: the higher the income, the higher the tax rate (e.g., U.S. Income Tax).
• Regressive tax rate: the higher the income, the lower the tax rate (e.g., FICA/Social Security Tax, or Old Age Survivors and Disability Insurance (OASDI)).
• Flat tax: the same tax rate is applied to the entire tax base
• Graduated tax: the tax base is divided into different brackets, and different tax rates apply to each bracket.

Income and Employment Taxes

• Income taxes are levied on individuals, corporations, estates, and trusts.
• Employment taxes include Social Security (OASDI) and Medicare.
• Social Security tax rate is 6.2% for both employer and employee, combining to 12.4%.
• Medicare tax rate is 1.45% for both employer and employee, combining to 2.9%.
• Total self-employment tax rate is 15.3% (12.4% + 2.9%).

Tax Rates Explained

• Marginal tax rate is the rate applied to the next additional increment of taxable income.
• Average tax rate is calculated as Tax liability/Taxable income.
• Effective tax rate is calculated as Tax liability/Total income (taxable and non-taxable).

Other Taxes

• Unemployment taxes: federal and state taxes fund temporary benefits for qualified individuals who lost their job through no fault of their own.
• Excise taxes are levied on products like gasoline, alcohol, tobacco, phone services, cable services, and air transportation.
• Estate and gift taxes are levied on wealth transfers upon death or by gift, with only large transfers being subject to these taxes.
• Sales tax is imposed on retail sales of merchandise and some services.
• Use tax is imposed on the use of merchandise where a sales tax applies, but the merchandise was purchased outside of the taxing jurisdiction.
• Real estate taxes are assessed based on the value of the land and permanently attached structures.
• Personal property taxes are assessed based on the value of certain specific types of personal property.

Tax System Principles

• Sufficiency means the tax system provides enough money for the government, which is also called revenue.
• Certainty means taxpayers can determine when, where, and how to pay the tax.
• Convenience means tax can be collected without undue hardship to the taxpayer.
• Economy means the costs of administering the tax and achieving compliance by taxpayers are reasonable.

Explore the U.S. tax system, including its history since the Sixteenth Amendment. Understand tax equity, covering horizontal and vertical fairness. Learn about tax calculations, tax base, and different tax rate types.