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Course: Financial Literacy > Unit 10
Lesson 1: What are taxes?How taxes work
Ever wonder why we pay so many different types of taxes, who collects them, and what they're used for? This article will help answer those questions. We'll discuss various kinds of taxes, explain how they support essential public services, and make understanding taxes effortless and straightforward.
Taxes
When you hear the word "taxes," you might think of that stressful time at the beginning of the year when everyone is busy filing their tax returns and waiting for refunds. But did you know that taxes are actually a part of our lives all year round, even if you don't have a job?
That's right! We pay taxes on so many things, like the things we buy, the homes we live in, and even when we stay in a hotel. But why do we even have taxes and why do we have to pay them? Keep reading to learn about the different types of taxes we encounter and how they help keep our communities running.
Why do we have taxes?
Think of taxes like a group of friends chipping in to buy a pizza for everyone to share. Each person contributes a little bit of money (less than the cost of the pizza), and together, they can buy a pizza that everyone can enjoy. Just like the pizza, taxes are a way for everyone to contribute a portion of their money to pay for things that benefit the whole community.
We have to pay taxes because they help fund important services and programs that we all use and need, like schools, roads, parks, and hospitals. Without taxes, it would be difficult for the government to provide these services to everyone.
So, when you pay your taxes, it's like you're chipping in for a big, shared pizza that benefits everyone in your community. And just like how different toppings on a pizza cater to different tastes, the taxes we pay help support a variety of programs and services that make our lives better.
Which taxes do I pay?
There are many different types of taxes that help fund various services and programs in our communities. Here's a quick look at some of the most common ones:
- Income taxes: These are taxes you pay on the money you earn from a job, a business, or investments. The federal government and some state governments collect income taxes. The more you earn, the more you pay in taxes.
- Payroll taxes: These taxes are taken out of your paycheck to fund Social Security and Medicare, which provide retirement and health care benefits for older Americans. Both you and your employer contribute to payroll taxes. These taxes are taken out separately from your income tax.
- Sales taxes: When you buy goods and services, you might pay a sales tax. This tax is a percentage of the purchase price and is collected by state and local governments. The rate varies depending on where you live.
- Property taxes: If you own a home or other property, you'll pay property taxes. These taxes are based on the value of your property and help fund local services like schools and public safety. Property taxes are collected by local governments.
- Corporate taxes: Businesses pay taxes on their profits. These taxes are collected by the federal government and some state governments. Corporate taxes help fund various government programs and services.
- Estate and inheritance taxes: When someone passes away and leaves behind money or property, the government may collect estate or inheritance taxes. These taxes are based on the value of the assets and are collected by the federal government and some state governments.
- Excise taxes: These are taxes on specific goods, like gasoline, alcohol, and tobacco. Excise taxes are collected by federal, state, and local governments and are usually included in the price of the product.
- Hotel and occupancy taxes: When you stay in a hotel or other short-term rental, you might pay hotel and occupancy taxes. These taxes are collected by local governments and help fund local tourism and other community services.
- Toll taxes: When you use certain roads, bridges, or tunnels, you might have to pay a toll tax. These taxes are collected by state and local governments and help pay for the maintenance and construction of transportation infrastructure.
These are just some of the many types of taxes we encounter in our daily lives. While it might seem like a lot, each tax plays a role in funding the services and programs that make our communities better places to live.
Check your understanding
Meet the tax collectors: federal, state, and local governments
Now that you've learned about the different types of taxes, let's meet the tax collectors - the different levels of government! Federal, state, and local governments each have their own set of taxes they collect to fund various programs and services.
| Type of tax | Federal government | State government | Local government |
|---|---|---|---|
| Income taxes | ✓ | Some states | |
| Payroll taxes | ✓ | ||
| Sales taxes | ✓ | Some localities | |
| Property taxes | ✓ | ||
| Corporate taxes | ✓ | Some states | |
| Estate taxes | ✓ | Some states | |
| Excise taxes | ✓ | ✓ | Some localities |
| Hotel taxes | ✓ | ||
| Toll taxes | ✓ | Some localities |
Keep in mind that some taxes, like sales and excise taxes, can be collected by both state and local governments, depending on where you live.
What do taxes pay for?
Great, you've discovered the various types of taxes and who collects them! Now let's explore what taxes pay for. Taxes help fund important services and programs that serve our communities, like schools, roads, parks, and fire department.
| Government | Uses of taxes |
|---|---|
| Federal | Social Security, Medicare, national defense, environmental protection, research, federal programs, national parks |
| State | Education, health care, transportation, public safety, state programs, state parks |
| Local | Public schools, libraries, police and fire departments, local programs, local parks |
Keep in mind that the specific use of taxes can vary and often overlap. For example, schools receive most of the money from state and local government, but also receive a portion from the federal government, too.
Local police departments usually get their funding from local government to help keep neighborhoods safe. On the other hand, state police receive funding from state government, to protect and serve the entire state.
Do I have to pay taxes? If so, how much?
Everyone has to pay taxes in one way or another, but the types of taxes you pay and how much you pay can vary. Some taxes are the same for everyone, while others are progressive, meaning they depend on how much you earn or the value of your property.
Sales tax is an example of a tax that's the same for everyone. When you buy something, you pay a percentage of the purchase price as sales tax. It doesn't matter how much money you make; everyone pays the same rate. This is known as flat tax.
On the other hand, income taxes are examples of progressive tax. With income taxes, the more money you make, the higher your tax rate. This means that people with higher incomes pay a larger percentage of their income in taxes. So, progressive tax adjusts based on income or value of what is being taxed.
Some taxes, like excise taxes on gasoline or alcohol, happen automatically when you make a purchase. You might not even realize you're paying them because they're included in the price of the product. You cannot control how much you pay for these taxes. Other taxes, like income and property tax need to be calculated based on multiple factors, and there are ways that you can lower these.
There are different reasons for having flat and progressive taxation systems. Flat taxes, like sales tax, are simpler to understand and apply. Progressive taxes, like income and property taxes, are designed to be fairer by asking those who can afford to pay more to contribute a larger share.
So, yes, you do have to pay taxes! But remember, taxes help fund important services and programs that we all use and benefit from. And while some taxes are the same for everyone, others are designed to be fair and based on your ability to pay.
Want to join the conversation?
For sales tax, you say it is a flat tax. However, sales tax is based on the total price of an item, not one's income. 7% of a $50 total is $3.50, but that is 0.0175% of one's income if they only earn $20,000 a year and 0.0025% of one's income if they earn $40,000. Therefore, sales tax would be regressive in this example.(5 votes)
Yes. Sales tax is a regressive tax.(3 votes)
Regarding Income Tax. Is the Tax so great that you don't actually make more money?(3 votes)- It doesn't work quite that way in the USA any more. Some decades ago, when people who earned millions a year had to pay higher rates in the top income brackets, some of them, who didn't want to pay ANY taxes, would complain about their rates (though those only applied to the amounts OVER already high incomes).(3 votes)
- Are Payroll Tax prices included as your income for your Income Tax?(2 votes)
- Let's say that you earn $5000 per month. Your monthly paycheck will have a little over $1000 of that taken for your income tax. There will also be deductions for Social Security and Medicare. State and City income taxes (if your state or city collect those) will also reduce the portion of the $5,000 that you receive as "take home" pay.(2 votes)
- why do taxes not cover insusrne as in health(2 votes)
- In places like Norway, Sweden, Denmark, Finland and the UK, it is as you suggest. Taxes cover health care. The USA does not operate that way.(1 vote)
is there income tax in Florida(1 vote)- Residents of Florida pay sales tax, but not state income tax. This means that poorer people pay the same portion of their income to the state as rich people pay of theirs. It is very regressive.
Florida residents must, however, pay US Federal Income tax.(2 votes)
Okay, ive asked this once but i didnt really understand there answer so im asking again.
If you finish a course do you have to do the course challenge if all the units are 90% or above? On all Classes?(1 vote)- You don't have to do ANYTHING. You just finish and move on. If your mentor or teacher insists on you doing the course challenge, that's a different matter.(2 votes)
I don't understand the difference between payroll and income taxes.(1 vote)
Payroll taxes are amounts taken out of your paycheck that go towards Social Security and Medicare, and both you and your employer pay a part of it. Income taxes are based on how much money you make and are used to pay for a variety of government services; you calculate and pay these taxes every year. So, essentially every employee always pays 3 separate taxes: Social Security, Medicare (together called payroll), and income tax. Hope that helps!(2 votes)
Are Payroll Tax prices included as your income for your Income Tax?(1 vote)- Let's say that you have a job which pays $20 per hour. At the end of a 40 hour week, you'll have earned $800. But you won't get that much to take home.
First, "Payroll taxes" are deducted from the $800.These are your federal income, state income, and perhaps even city income taxes.
Next, Social Security insurance premiums are deducted, about 8.3%.
Next, Medicare insurance premiums are deducted, another 2.6%
Various other deductions to fund disability and workers' compensation coverage might also be deducted.
So, depending on where you live, of the $800 that you earned that week, you'll likely take home about $600 of it.(1 vote)
- I wonder if taxes is just so the government has money(1 vote)
Yes, the government needs money for schools, roads, national parks, and all the things. The government also prints money. So why print it, pay us all, and then take a bunch of it back?
You cannot pay your U.S. taxes in Bitcoin, airline miles, sacks of grain, collectibles, or anything besides U.S. dollars, even if those other things have value. The other part of the reason for collecting taxes is to give the currency its value. (There's a very long book titled Debt: The First 5000 Years, if you want to know more than you ever thought possible about how money works.)(1 vote)
- Are Payroll Tax prices included as your income for your Income Tax?(1 vote)
- You get paid for your work.
Some taxes are deducted from your pay before you get it, and are paid to the government ahead of time. That way you don't get to the end of the year without enough money to pay them.
Your federal income tax and state income tax (if your state has such) are deducted. These are taxes.
Other deductions are made for retirement and health insurance purposes.
Though these other deductions are not "taxes", they come out of your pay before you get what's left.(1 vote)