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Principles and Systems of Taxation

Instructor: Christine Serva

Christine is an instructional designer, educator, and writer with a particular interest in the social sciences and American studies.

In this lesson, you'll gain a better understanding of how our tax system works. Look into the different levels of taxation from the federal government to state and local governments.

Tax Time

If you've ever received a paycheck as an employee, you will notice on your paystub that taxes were withheld, to be paid to the government. (You're probably groaning just thinking about it!) By April 15, you may have worked with an accountant or software program to help you determine whether you owe the government some money, or the government owes you a refund.

In this lesson, we'll take a deeper look into taxes at different levels - national, state, and local - and what principles underlie our tax system in the United States.

Federal Taxes

At a national level, the federal government gets most of its funding from income taxes. This means that for everyone out there working, and for every business, there is money coming into the government in the form of federal taxes.

A main principle of the United States federal income tax is something called the progressive tax system. This means the more you earn, the higher percentage of taxes you have to pay.

Imagine it wasn't this way, and that everyone paid the same percentage of their income to the government, let's say 25%, no matter how much you earn. That 25% would probably feel like a much bigger chunk to someone who earns $500 per week, compared with someone who earns $5,000 per week, even though the person earning $5,000 is paying much more tax overall.

What the progressive tax system aims to do is base the tax rate on a person's ability to pay. So, in 2015, a single person making $9,000 per year, for example would pay 10% of their income to federal taxes ($900), while a person making $415,000 per year would pay almost 40% (about $166,000).

In reality, the actual amount a person pays will be a bit different than these figures because of deductions that reduce the total amount that gets taxed. In addition, those who have investments that pay off must report this amount so they can be taxed on the money they gain from investing.

Federal income taxes involve calculations known as deductions.
Examples of federal tax forms

Income taxes aren't the only type of tax at the federal level, though. For example, luxury taxes on certain items like gas and liquor also contribute to the pool of money the federal government uses to provide goods and services. The money gained by federal taxation goes to such programs as Medicare and Social Security, the armed forces, and grants the channel money to state and local governments for them to provide services to the public.

State Taxes

Most states also have an income tax. Some have a progressive tax system, similar to the federal government, while others have a flat rate tax, meaning that everyone pays an equal percentage of their income.

In addition to income taxes, states may also gain funds through sales tax. Think of how your bill for purchases often totals more than just the items on the list of what you buy, because tax is added on top of that. Certain items can be taxed, while others are not. For example, many states tax the purchase of clothing, while they don't tax most groceries.

It's important to note that every state's tax system is a bit different, and sometimes a lot different! At the time this lesson was written, New Hampshire doesn't have income tax or sales tax. Other taxes, like state property taxes, help to make up the difference to help fund the programs of their state government.

Local Taxes

Property taxes make up the bulk of revenue for local government. Even though you may pay a small amount to local government based on your income, if you own a home, then you will feel the impact of the property tax more.

Property value is important to calculating local tax in many areas.
A house and yard

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