Income Taxes

When you get your paycheck at the end of the first pay period at a new job, it's always interesting to see your net pay. Most of us expect more than we get. By the time you get your check, it has been cut up like a piece of pie, with several entities taking a piece of the pie. The entities that take money differ from person to person, company to company and state to state. However, almost every income earner has to pay federal income tax.

An income tax is a tax levied on the financial income of persons, corporations, or other legal entities. Various income tax systems exist, with varying degrees of tax incidence. Income taxation can be progressive, proportional, or regressive. When the tax is levied on the income of companies, it is often called a corporate tax, corporate income tax, or profit tax. Individual income taxes often tax the total income of the individual, with some deductions permitted, while corporate income taxes often tax net income which is the difference between gross receipts, expenses, and additional write-offs. (Rubin, 2007)

We generally don't think much about taxes except during the annual tax season. It's probably the most dreaded time of the year for millions of Americans, yet we circle it on our calendars along with holidays and birthdays. But little joy is connected to April 15, which is the deadline for filing tax forms; this deadline doesn't always fall on the 15th.

The tax system is a huge machine with a tax code that seems more complex than rocket science. Examination of how individual income taxes work and a look at the history of income taxes in the United States will be discussed.

The "tax net" refers to the types of payment that are taxed, which included personal earnings, capital gains, and business income. The rates for different types of income may vary and some may not be taxed at all. Capital gains may be taxed when realized (e.g. when shares are sold) or when incurred (e.g. when shares appreciate in value). Business income may only be taxed if it is significant or based on the manner in which it is paid. Some types of income, such as interest on bank savings, may be considered as personal earnings or as a realized property gain (similar to selling shares). In some tax systems, personal earnings may be strictly defined where labor, skill, or investment is required; in others, they may be defined broadly to include windfalls (e.g. gambling wins).

Tax rates may be progressive, regressive, or flat. A progressive tax taxes differentially based on how much has been earned. For example, the first $10,000 in earnings may be taxed at 5%, the next $10,000 at 10%, and any more income at 20%. The tax code is not only a means of raising revenue to pay for government services. It also impacts an astonishing array of economic and social activities, from homeownership to education and child care to support for low-income workers. Taxes contribute, as part of the problem or as part of the solution, to many of the challenges our nation faces. The present tax treatment of health insurance, for example, pushes health spending upward while offering many of the uninsured little help in getting coverage. The tax treatment of retirement savings provides a windfall for high-income Americans who would likely have saved anyway, while offering scant encouragement to saving by low- and moderate-income Americans, many of whom face the prospect of an insecure retirement. (Brodoff & Summers, 2007) The progressive tax system, and the nation's fiscal system more broadly, have historically played an important role in expanding opportunities for all Americans while reducing inequality. But the same dynamic forces of technological change, financial innovation, and globalization that have contributed to rising income inequality also present new challenges for progressive taxation. Financial engineering, for example, has made it easier for the financially sophisticatedвЂ"typically the wealthyвЂ"to take advantage of new financial instruments that shelter their gains from tax. And as capital is able to move ever more quickly and easily across borders, corporate income becomes increasingly elusive of taxation. These forces, together with deliberate policy changes, have led to an erosion of progressivityвЂ"the principle that higher incomes should face higher rates of taxationвЂ"and a dramatic reduction in the average tax rate facing very high-income households. More than half of that decline is the result of declining effective corporate tax rates, as high-income households own disproportionate amounts of capital. (Brodoff & Summers, 2007) Alternatively, a flat tax taxes all earnings at the same rate. Unlike the current system, a flat tax is simple, fair, and good for growth. Instead of the 893 forms required by the current system, a flat tax would use only two postcard-sized forms: one for labor income and the other for business and capital income. Unlike the current system, which discriminates based on the source, use, and level of income; a flat tax treats all taxpayers equally, fulfilling the “equal justice under law” principle etched above the main entrance to the U.S. Supreme Court building. And unlike the current system, which punishes people for contributing to the nation’s wealth, a flat tax would lower marginal tax rates and eliminate the tax bias against saving and investment, thus ensuring better economic performance in a competitive global economy.

There has been several flat tax proposals over the years, all of them based on the path breaking proposal developed by two Hoover Institution economists. While no two plans are identical, they all share common features that fix the major flaws of the current Internal Revenue Code. Simplicity and fairness are also natural consequences of these component features of tax reform.

These major features of a flat tax are:

A Single Flat Rate. All flat tax proposals have a single rate, usually less than 20 percent. The low, flat rate solves the problem of high marginal tax rates by reducing penalties against productive behavior, such as work, risk taking, and entrepreneurship.

Elimination of Special Preferences. Flat tax proposals would eliminate provisions of the tax code that bestow preferential tax treatment on certain behaviors and activities. Getting rid of deductions, credits, exemptions, and other loopholes also helps solve the problem of complexity, allowing taxpayers to file their tax returns on a postcard-sized form.

No Double Taxation of Saving and InvestÐ'¬ment. Flat tax proposals would eliminate the tax code’s bias against capital formation by ending the double taxation of income that is saved and invested. This means no death tax, no capital gains tax, no double