A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
Why Do We Pay Taxes?
Taxes have been a staple of governance around the globe for over 5,000 years and are the mechanism by which a government can provide goods and services for its citizens, who may not be able to access them otherwise.
Governments do not sell products or have profits, so the only way to fund services is by asking us to pay taxes on the money we earn, things we buy, and property we own. Whether you support higher or lower taxes, the reality is that you likely benefit from what they make possible in your daily life. Taxes allow for projects and services like roads and infrastructure, emergency services, education, and national defense, just to name a few.
Some taxes, like property taxes, fund local services such as schools, fire departments, and police. Others, like excise taxes on liquor, cigarettes, and sugar, discourage unhealthy behaviors that lead to broad, societal costs.
Put simply, everyone pays taxes. What specific taxes you pay and at what rate are dependent on many factors like where you are located, what you earn, what you own, what you buy, credits and deductions, and more.
Direct v. Indirect Taxes
Taxes can be levied in two ways: directly or indirectly. A direct tax is levied on individuals and organizations and cannot be shifted to another payer. With a direct tax, such as the individual income tax, rates often increase as the taxpayer’s ability to pay increases, resulting in what is called a progressive tax.
Unlike direct taxes, indirect taxes are levied on goods and services, not individual payers, and are collected by the retailer or manufacturer. An indirect tax is imposed on one person or group, then shifted to a different payer, usually the consumer. Sales and Value-Added Taxes (VATs) are two examples of indirect taxes.
What Is the Difference Between Taxes and Other Payments?
Not all government revenue is generated from tax collections. Fines and user fees are also charges levied by the government but are not considered taxes.
The main objective of a tax is to raise revenue, which distinguishes them from fees and fines. Fees are levied to offset the cost of providing a service. An example is paying a small fee to enter a state park, which covers the cost of staff and park maintenance. Fines are different from taxes because their main objective is to penalize an unlawful or harmful act, like fines for littering.
Fees and penalties may not be taxes, but taxes do come under many different names. Other titles for taxes include:
- Assessment
- Duty
- Tariff
- Customs
- Capitation
- Levy
- Millage
- Impost/Imposition
What Constitutes “Good” Tax Policy?
In tax policy, there are ever-present trade-offs among how much revenue a tax will raise, who bears the burden of a tax, and what impact a tax will have on economic growth. Tax Foundation has four principles of sound tax policy that should guide policymakers.
The principles of sound tax policy are simplicity, transparency, neutrality, and stability. Tax codes should be easy for taxpayers to comply with and for governments to administer and enforce. It should also clearly and plainly define what taxpayers must pay and when they must pay it. Hiding tax burdens in complex structures should be avoided and any changes to the tax code should be made with careful consideration, input, and open hearings.
Sound tax policy should neither encourage nor discourage personal or business decisions because the purpose of taxes is to raise needed revenue, not to favor or punish specific industries, activities, and products.
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