The structure of a tax is often justified on the basis of one of two general principles. First, a tax could relate to the individual’s ability to pay, so those with a greater ability pay more taxes. Income or property taxes often rely on this ability-to-pay tax principle. Alternatively, the benefits-received tax principle relates taxes to the benefits taxpayers receive from the government activity funded by the tax. For example, the tax on gasoline funds highway construction and maintenance, thereby linking tax payment to road use, since those who drive more, pay more gas taxes. Tax incidence indicates who actually bears the burden of the tax. One way to evaluate tax incidence is by measuring the tax as a percentage of income. Under proportional taxation, taxpayers at all income levels pay the same percentage of their income in taxes. A proportional income tax is also called a flat tax, since the tax as a percentage of income remains constant, or flat, as income increases. Note that under proportional taxation, although taxes remain constant as a percentage of income, the dollar amount of taxes increases proportionately as income increases.
Under progressive taxation, the percentage of income paid in taxes increases as income increases. The marginal tax rate indicates the percentage of each additional dollar of income that goes to taxes. Because high marginal rates reduce the after-taxreturn from working or investing, high marginal rates can reduce people’s incentives to work and invest. The six marginal rates applied to the U.S. personal income tax ranged from 10 to 35 percent in 2012, down from a range of 15 to 39.6 percent in 2000. The top rate was scheduled to return to 39.6 percent in 2013. The top marginal tax bracket each year during the history of the personal income tax is shown by Exhibit 5. Although the top marginal rate is now lower than it was during most other years, high-income households still pay most of the federal income tax collected About 40 percent of U.S. households pay no federal income tax.
Under progressive taxation, the percentage of income paid in taxes increases as income increases. The marginal tax rate indicates the percentage of each additional dollar of income that goes to taxes. Because high marginal rates reduce the after-taxreturn from working or investing, high marginal rates can reduce people’s incentives to work and invest. The six marginal rates applied to the U.S. personal income tax ranged from 10 to 35 percent in 2012, down from a range of 15 to 39.6 percent in 2000. The top rate was scheduled to return to 39.6 percent in 2013. The top marginal tax bracket each year during the history of the personal income tax is shown by Exhibit 5. Although the top marginal rate is now lower than it was during most other years, high-income households still pay most of the federal income tax collected About 40 percent of U.S. households pay no federal income tax.
According to the U.S. Internal Revenue Service, the top 1 percent of tax filers, based on income, paid 38 percent of all income taxes collected in 2008. Their average tax rate was 23.3 percent. And the top 10 percent of tax filers paid 70 percent of all income taxes collected. Their average tax rate was 18.7 percent. In contrast, the bottom 50 percent of tax filers paid only 2.6 percent of all income taxes collected. Their tax rate averaged only 3.0 percent. Whether we look at marginal tax rates or average tax rates, the U.S. income tax is progressive. High-income filers pay the overwhelming share of income taxes.
Finally, under regressive taxation, the percentage of income paid in taxes decreases as income increases, so the marginal tax rate declines as income increases. Most U.S. payroll taxes are regressive, because they impose a flat rate up to a certain level of income, above which the marginal rate drops to zero. For example, Social Security taxes were levied on the first $110,100 of workers’ pay in 2012. Ordinarily, employers pay 6.2 percent and employees pay 6.2 percent (the self-employed pay the entire 12.4 percent).
Taxes often do more than fund public programs. Some taxes discourage certain activity. For example, a pollution tax can help clean the air. A tax on gasoline can encourage people to work at home, car pool, or use public transportation. Some taxes have unintended consequences. For example, in Egypt a property tax is not imposed until a new building is complete. To avoid such taxes, builders never finish the job; multistory dwellings are usually missing the top floor. As another example of how taxes can distort the allocation of resources, property taxes in Amsterdam and Vietnam were originally based on the width of the building. As a result, buildings in those places are extremely narrow. Such taxes distort the efficient allocation of resources.
Finally, under regressive taxation, the percentage of income paid in taxes decreases as income increases, so the marginal tax rate declines as income increases. Most U.S. payroll taxes are regressive, because they impose a flat rate up to a certain level of income, above which the marginal rate drops to zero. For example, Social Security taxes were levied on the first $110,100 of workers’ pay in 2012. Ordinarily, employers pay 6.2 percent and employees pay 6.2 percent (the self-employed pay the entire 12.4 percent).
Taxes often do more than fund public programs. Some taxes discourage certain activity. For example, a pollution tax can help clean the air. A tax on gasoline can encourage people to work at home, car pool, or use public transportation. Some taxes have unintended consequences. For example, in Egypt a property tax is not imposed until a new building is complete. To avoid such taxes, builders never finish the job; multistory dwellings are usually missing the top floor. As another example of how taxes can distort the allocation of resources, property taxes in Amsterdam and Vietnam were originally based on the width of the building. As a result, buildings in those places are extremely narrow. Such taxes distort the efficient allocation of resources.
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