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An in-depth understanding of taxes

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Tax Students: An in-depth understanding of taxes

Taxes help improve and increase the standard of living in a country. For the economy to flourish, there have to be good roads, telephones, electricity and other operational necessities. This is why governments collect money from taxes and use it to develop the economic activity within the country.

Collecting taxes ensures that businesses will thrive so every citizen can reap its benefits. However, taxes, as well as the rules that come along with them, are some of the most complex and confusing topics in the field of finance. This is mainly due to the various types of taxes being collected.

Today, Tax students will have an in-depth look at the various types of taxes as well as the reasons why paying taxes is important. Read on to learn more:

What is tax

A tax is a financial charge on an individual or legal entity by the government to fund various public and national expenses that will help improve the country’s economy. Failure to pay taxes is considered as evasion or resistance which is punishable by law. Some countries charge a flat rate while some base the taxes on brackets of annual income amounts.

In economics, taxes are considered as wealth that is transferred from households to businesses to the government which may positively or negatively affect the economic growth of the country. But the definition of taxes differs in some ways since economists do not see other transfers to the government as taxes such as public universities tuition and local government utility fees.

Purpose and effects of taxes on the economy

The purpose of collecting taxes is to raise revenue and use the money to carry out public and national functions such as:

  • Infrastructure (public roads, transportation, legal systems, security, education and health systems)
  • Military
  • Scientific research
  • Culture and arts
  • Public works
  • Public insurance (pensions, unemployment benefits and subsidies)
  • Public utilities (Energy, water and waste management)

When the national expenses exceed the total taxes collected from people, the government will be in debt. But as per the chartalist theory of money creation, the government does not need taxes as long as it can issue fiat money. According to the view of the theory’s proponents, the purpose of the tax is just to maintain the stability of the country’s currency.

Why do various types of taxes exist

You might wonder why certain individuals need to pay different taxes than other people and why some taxes vary in rates. The government does this to distribute the tax burden among different classes of people fairly.  A country or state’s tax system reflects the values of those in the current political power since they are the one who makes the choices on who will pay the taxes and how much they will pay.

Types of taxes

Take a look at the various types of taxes below:

Income taxes

Income tax is levied on individuals and business entities such as corporations. Generally, this type of tax is being imposed based on the net profits or net gains of the business or an individual. The computation of the amount subject to taxation depends on the accounting principle used by the state or country.

In addition, the rate of tax can either be flat or determined based on the income level. Most tax agencies collect personal income tax as you collect your earnings. The corrections are made before the year ends which may require you to pay more or be refunded.

  • Negative income tax

The negative income tax or (NIT) is a system where the government gives supplemental payment to those who earn below a certain amount of income which is determined by the government. People who are qualified for NIT do not need to pay taxes but will receive support from the government instead.

  • Capital gains tax

The capital gain is a profit earned on the sale of assets that are not kept for sale in the usual course of business. In many countries, personal assets are considered capital assets. For capital gains, several governments provide favourable tax rates or simply partial taxes depending on how long the asset has been kept. 

Since capital gains are sometimes taxed at lower rates than ordinary income, there is substantial debate and disagreement concerning the precise definition of capital.

  • Corporate tax

Income tax, capital tax, net-worth tax and other taxes placed on firms are referred to as corporate taxes. Companies may have different tax rates and taxable bases than individuals or other taxable entities.

  • Social security contributions

Many countries have retirement and healthcare programs run by the government.   Typically, the country requires employers and/or workers to make mandatory payments in line with these services.  These payments are often calculated based on wages or self-employment earnings.

The contribution amounts are generally fixed, but employers and workers may be charged at various rates.  Some systems include a cap on the amount of money that can be taxed. Only salaries above a certain level are subject to the tax in a few systems. These higher and lower limits may apply to the pension portion of the tax, but not to the healthcare portion. Some believe that these taxes are more of a type of ‘forced savings’ than a true tax.

  • Payroll tax

Companies are frequently subjected to unemployment and other taxes depending on their overall payroll. These taxes can be applied at the national level.

  • Wealth tax

The whole value of personal assets, such as bank accounts, real estate, insurance and retirement plans and personal trusts, is subject to a wealth tax. Liabilities such as mortgages and other debts are often deducted, which is why it is sometimes referred to as a net wealth tax.

Property taxes

Real estate and some types of moveable property may be subject to recurring property taxes. Many countries levy an estate tax, a gift tax or other taxes on property acquired at death or as a gift. These types of taxes are usually charged every year. It also includes vehicle and boat registration fees. Take a look at more types of taxes under property taxes below:

  • Inheritance tax

There are taxes levied on the death of an individual known as inheritance tax and estate tax. An inheritance tax is levied on the person who inherits money or property from a deceased person, while the estate tax is imposed on the deceased person’s property or money.

  • Expatriation tax

The expatriation tax is a fee imposed on those who give up their citizenship or place of residence. The tax is often levied based on the assumed disposal of the person’s whole estate. For example, in the United States, anyone who renounces his or her citizenship status and leaves the country with a net worth of $2 million is assumed to have done so to avoid paying taxes, thus they are subjected to a higher tax rate.

  • Transfer tax

A stamp is typically required to make a deal legal in many countries. The stamp fee is either a set amount or a percentage of the transaction’s total value. This type of tax has been removed in most countries, but it still exists for some.

  • Wealth tax

Some governments would demand disclosure of the taxpayer’s assets and liabilities sheet to calculate a tax on their net worth. Based on that data, a tax might be imposed.

Goods and services

In some countries, a value-added tax (VAT), also known as Goods and Services Tax (G.S.T) is applied to any operation that generates value. By using computer systems, several tax authorities have adopted automatic VAT, which has boosted control and integrity while also permitting anti-cybercrime offices. Check out the taxes under goods and services below:

  • Sales tax

When a product is sold to its final consumer, sales taxes are charged. Retailers argue that such fees are major hindrances to retail sales. Because those with higher incomes spend a smaller percentage of their income, a flat-rate sales tax will be unfair. Food, utilities, and other needs are often exempted from sales taxes, as poor people spend a greater proportion of their income on these items, making such exclusions fairer.

  • Excise tax

Excise duty is an indirect tax levied on commodities during the manufacture, production and distribution process, It is generally equal to the amount or value of the items.  The term is most commonly used to refer to a tax on goods produced or made in a country.

  • Tariff

An import or export tariff is a tax imposed on products moving through a political border. Tariffs restrict trade and are used by governments to protect local industries. A part of tariff proceeds is often held in a trust to pay for the government’s military or border patrol. Smuggling and claiming a false value of products are two common means of evading tariffs. 

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