The Three Basic Tax Types

Key Takeaways

• Taxes have a much bigger impact on our lives beyond just paying a little more for the things we buy. The better you understand them, the better equipped you are to make decisions about them.
• All taxes can be divided into three basic types: taxes on what you buy, taxes on what you earn, and taxes on what you own.
  • Sales taxes are paid by the consumer when buying most goods and services. These taxes provide state and local revenue, funding services like education, transportation, and health care.
  • Income taxes are paid on many sources of income you might earn, like the taxes taken directly from your paycheck. They are major sources of revenue for the federal government, many state governments, and a few local governments.
  • Property taxes generate revenue at a local level. They provide funding for everything from parks, to public safety services, to additional funding for schools.
• It’s important to remember that every dollar you pay in taxes starts as a dollar earned as income. One of the main differences among the tax types outlined below is the point of collection—in other words, when you pay the tax.
  • For example, if you earn $1,000 in a state with a flat income tax rate of 10%, $100 in income taxes should be withheld from your paycheck when you earn that income.
  • If, a week later, you take $100 from your remaining earnings to purchase a new smartwatch in a jurisdiction with a 5% sales tax, you’ll pay an additional $5 in taxes when you purchase that item.
  • Altogether, $105 of your initial $1,000 in income has been collected in taxes, just not at the same time.
• Tax structures and levels vary greatly among U.S. states and countries, as do the services they fund.
• Every dollar you pay in taxes affects how much of your income you get to keep, save, and spend, so understanding each tax type can help you make better decisions about everything from which job to take, to where to live, to how you vote.