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Income Tax

Ah, taxation. A topic as enduring and inevitable as the universe's slow creep toward entropy. You want me to dissect Wikipedia's take on income tax? Fine. Don't expect me to be thrilled about it. Just another set of rules designed to extract resources, dressed up in the guise of societal contribution.

Tax based on Taxable Income

Part of a series on Taxation An aspect of Fiscal policy

Policies • Economic justice • Government revenue • Property tax equalization • Tax revenue • Non-tax revenue • Tax law • Tax bracket • Flat tax • Tax threshold • Taxation as theft • Tax shift • Tax cut • Tax advantage • Tax incentive • Tax reform • Double taxation • Tax harmonization • Tax competition • Voluntary taxation • Representation

Economics General Theory • Price effect • Excess burden • Tax efficiency • Tax incidence • Laffer curve • Optimal tax • Fiscal illusion • Theories • Optimal capital income taxation

Distribution of Tax • Tax rate • Flat • Progressive • Regressive • Proportional

Collection • Economic nexus in the United States • Revenue service • Revenue stamp • Tax assessment • Taxable income • Tax lien • Tax refund • Tax shield • Tax residence • Tax preparation • Tax protester • Tax investigation • Tax collector • Tax withholding • Private tax collection

Noncompliance Legal tax avoidance • Base erosion and profit shifting (BEPS) • Double Irish • Single Malt • CAIA • Dutch Sandwich • Estate planning • Fuel dye • Repatriation tax avoidance • Share repurchase • Tariff engineering • Tax credit • Tax deduction • Tax exemption • Taxpayer groups • Tax holiday • Tax inversion • Tax farming • Tax patent • Tax shelter

Illegal tax evasion • Tax amnesty • Black market • Debtors' prison • Tax exile • Smuggling • Tax resistance • Transfer mispricing • Unreported employment

Locations • Tax havens • Corporate havens • Offshore financial centres (OFCs) • Offshore magic circle • Conduit and sink OFCs • Financial centres • Financial Secrecy Index

Major examples • Ireland as a tax haven • Ireland v. Commission • Leprechaun economics • Liechtenstein tax affair • Luxembourg Leaks • Offshore Leaks • Paradise Papers • Panama Papers • Swiss Leaks • United States as a tax haven • Panama as a tax haven

Types • Direct • Indirect • Per unit • Ad valorem • Aviation • Airport improvement • Landing • Solidarity • Capital gains • Expatriation • Consumption • Departure • Hotel • Sales • Stamp • Television • Tourist • Value-added • Digital goods • Dividend • Environmental tax • Carbon • Eco-tariff • Landfill • Natural resources consumption • Severance • Steering • Stumpage • Excise • Alcohol • Cigarette • Fat • Meat • Sin • Sugary drink • Tobacco • General • Georgist • Gift • Gross receipts • Hidden • Hypothecated • Income • Inheritance (estate) • Land value • Luxury • On childlessness • Payroll • Pigouvian • Property • Resource rent • Single • Stealth • Surtax • Turnover • Use • User charge/fee • Congestion • Fuel • Road/GNSS • Toll • Vehicle miles traveled • Corporate profit • Excess profits • Windfall • Negative (income) • Wealth

International • Financial transaction tax • ATTAC • Currency transaction tax • European Union Common Consolidated Corporate Tax Base (CCCTB) • Global minimum corporate tax rate • Robin Hood tax • Tobin tax • Spahn tax • Tax equalization • Tax treaty • Exchange of Information • Permanent establishment • Transfer pricing • European Union FTT • Foreign revenue rule

Trade • Custom • Duty • Tariff • Import • Export • Tariff war • Free trade • Free-trade zone • Trade agreement • ATA Carnet

Research Academic • Mihir A. Desai • Dhammika Dharmapala • James R. Hines Jr. • Ronen Palan • Joel Slemrod • Gabriel Zucman

Advocacy groups • Institute on Taxation and Economic Policy (ITEP) • Oxfam (UK) • Tax Foundation (US) • Tax Justice Network (TJN) • Tax Policy Center (US)

Religious • Church tax • Eight per thousand • Teind • Tithe • Fiscus Judaicus • Leibzoll • Temple tax • Tolerance tax • Jizya • Kharaj • Khums • Nisab • Zakat

By country All Countries • List of countries by tax rates • Tax revenue to GDP ratio • Tax rates in Europe

Individual Countries • Albania • Algeria • Argentina • Armenia • Australia • Azerbaijan • Bangladesh • Bhutan • Brazil • Bulgaria • BVI • Canada • China • Colombia • Croatia • Denmark • Finland • France • Germany • Greece • Hong Kong • Iceland • India • Indonesia • Iran • Ireland • Israel • Italy • Japan • Kazakhstan • Lithuania • Malta • Morocco • Namibia • Netherlands • New Zealand • Norway • Pakistan • Palestine • Peru • Philippines • Poland • Portugal • Russia • South Africa • Sri Lanka • Sweden • Switzerland • Taiwan • Tanzania • United Arab Emirates • United Kingdom • United States • Uruguay

• Business • Money • v • t • e

An income tax is a tax imposed on individuals or entities (taxpayers) in respect of the income or profits earned by them (commonly called taxable income). It’s a rather straightforward concept, really: you earn, you pay. The rate is typically a percentage applied to whatever you’ve managed to accumulate after expenses. This rate, however, is where things get… interesting. It can shift based on who you are – an individual, a corporation – and the very nature of the income itself. For corporations, it's usually a single, flat rate, which is almost amusingly simple compared to the elaborate dances individuals are forced to perform.

Individual income, on the other hand, is often subjected to a progressive tax system. This means the more you earn, the higher the percentage taken from each additional dollar. Think of it like a tiered system: the first chunk of your income might be tax-free, the next chunk taxed at a modest rate, and then each subsequent chunk taxed at an ever-increasing rate. It’s a rather elegant way to ensure that those with the most are also the ones contributing the most, at least in theory. Most jurisdictions, bless their hearts, do exempt local charitable organizations from this burden, a small mercy in the grand scheme of things. Income derived from investments, naturally, often gets a preferential, lower tax rate. And then there are the credits – little magical tickets that can reduce your tax liability, like finding a perfectly preserved artifact in the desert. Some places even impose the higher of your calculated income tax or a tax based on an alternative measure of your income, just to keep you on your toes.

The taxable income for residents is typically your total earnings minus any expenses incurred in generating that income, plus other deductions. Generally, only the net gain from selling property, including goods you intended to sell, is counted as income. For shareholders in a corporation, their income usually includes any distributions of profits. Deductions are broad, encompassing all expenses related to your business or income-generating activities, and even an allowance for the wear and tear of business assets. Individuals might get to deduct certain personal expenses, too, though the generosity varies. Most jurisdictions either ignore income earned outside their borders or offer a credit for taxes paid elsewhere. Non-residents, predictably, are only taxed on specific types of income sourced within the jurisdiction. It’s a system designed to ensure no loophole, however small, goes unexploited by the revenue-collecting apparatus.

History

The idea of taxing income is a relatively modern invention, predicated on the existence of a money economy, reasonably meticulous accounts, a shared understanding of what constitutes receipts, expenses, and profits, and a stable society with reliable record-keeping. For millennia, these conditions were largely absent. Taxes were levied on tangible assets like wealth, social standing, or ownership of the means of production, typically land and slaves. Practices like tithing, or offering the first fruits, existed from antiquity and could be seen as a distant ancestor of income tax, but they lacked the precision and the concept of net increase that defines modern taxation.

Early Examples

In 9 CE, China's Xin dynasty under Emperor Wang Mang introduced an income tax, a 10% levy on net earnings from activities like collecting wild herbs and fruits, fishing, shepherding, and various non-agricultural pursuits and trade. This was a remarkably early attempt at taxing economic activity. People were required to report their earnings to the government, and officials conducted audits. The penalty for evasion was severe: a year of hard labor and confiscation of all property. Unsurprisingly, this progressive measure was met with popular discontent and abolished in 22 CE.

In the early Roman Republic, taxes were more modest, focusing on owned wealth and property. The rate was typically 1%, sometimes rising to 3% during wartime. Taxes were assessed on land, homes, slaves, animals, personal items, and monetary wealth – the more property you possessed, the higher your tax burden.

One of the earliest recorded taxes on income was the Saladin tithe, instituted by Henry II in 1188 to fund the Third Crusade. This tithe demanded that every layperson in England and Wales pay one-tenth of their personal income and movable property.

Portugal introduced its own personal income tax, the décima, in 1641.

Modern Era

United Kingdom

The modern income tax is generally considered to have originated in 1799, at the suggestion of Henry Beeke, who would later become Dean of Bristol. It was introduced by Prime Minister William Pitt the Younger in December 1798, intended to finance the purchase of weapons and equipment for the French Revolutionary War. Pitt's progressive income tax started with a rate of 2 old pence per pound (1/120th) on incomes exceeding £60 (roughly equivalent to £6,700 in 2023). The rate climbed to a maximum of 2 shillings per pound (10%) for incomes over £200. Pitt anticipated raising £10 million annually, but the actual receipts for 1799 barely exceeded £6 million.

Pitt's income tax was in effect from 1799 to 1802, when Henry Addington abolished it during the Peace of Amiens. Addington had become prime minister in 1801 after Pitt resigned over Catholic Emancipation. The income tax was reinstated by Addington in 1803 when hostilities with France resumed, only to be abolished again in 1816, a year after the Battle of Waterloo. Opponents, who believed the tax should be solely for wartime financing, demanded the destruction of all records related to it. While the Chancellor of the Exchequer publicly burned records, copies were secretly preserved in the tax court's basement.

Punch magazine illustrated the unpopularity of a proposed 1907 income tax.

The income tax was reintroduced by Sir Robert Peel through the Income Tax Act 1842. Peel, a Conservative, had opposed income tax during the 1841 general election, but a mounting budget deficit necessitated new revenue streams. This new income tax, modeled after Addington's system, applied to incomes above £150 (equivalent to £19,487 in 2023). Despite initial intentions for it to be temporary, it soon became an entrenched part of the British fiscal landscape.

In 1851, a committee led by Joseph Hume was formed to examine the issue, but it failed to reach a decisive conclusion. Despite vocal opposition, William Gladstone, serving as Chancellor of the Exchequer from 1852, retained the progressive income tax and expanded its scope to cover the expenses of the Crimean War. By the 1860s, the progressive tax had become a reluctantly accepted component of the United Kingdom's fiscal system.

United States

The US federal government implemented its first personal income tax on August 5, 1861, as a means to finance the American Civil War. This tax imposed a 3% rate on incomes exceeding US800(equivalentto800 (equivalent to 21,900 in 2024). This initial tax was subsequently repealed and replaced by another income tax in 1862. The first peacetime income tax was enacted in 1894 via the Wilson-Gorman tariff. This tax levied a 2% rate on incomes over 4,000(equivalentto4,000 (equivalent to 129,000 in 2024), meaning fewer than 10% of households would be affected. The primary objective of this income tax was to compensate for revenue lost due to tariff reductions. However, the US Supreme Court declared this income tax unconstitutional in Pollock v. Farmers' Loan & Trust Co., citing the Tenth Amendment's reservation of powers not explicitly delegated to the federal government, and the lack of constitutional authority to impose a direct tax without apportionment.

The obstacle to a federal income tax was removed in 1913 with the ratification of the Sixteenth Amendment to the United States Constitution. In the fiscal year 1918, for the first time, annual internal revenue collections surpassed the billion-dollar mark, soaring to $5.4 billion by 1920. The proportion of income collected through income tax has fluctuated dramatically, from a mere 1% for the lowest bracket in the early days of the US income tax to rates exceeding 90% for the highest bracket during World War II.

Timeline of introduction of income tax by country

Common Principles

Despite the wide variations in tax rules, certain fundamental principles underpin most income tax systems. Countries like Canada, China, Germany, Singapore, the United Kingdom, and the United States, among many others, adhere to most of the principles detailed below. Some systems, such as that of India, might exhibit significant deviations. The following are general examples; for specifics, consult the individual articles by jurisdiction (e.g., Income tax in Australia).

Taxpayers and Rates

Individuals are typically taxed at different rates than corporations. "Individuals" refers strictly to human beings. Tax systems outside the US generally classify an entity as a corporation only if it's legally structured as one. Estates and trusts usually fall under special tax provisions. Other taxable entities are commonly treated as partnerships. In the US, however, many entity types have the option to elect corporate or partnership tax treatment. Partners in a partnership are treated as receiving their share of the partnership's income, deductions, and credits.

Each taxpayer meeting specific minimum criteria is assessed separately. Many systems permit married individuals to opt for joint assessment. Likewise, controlled groups of locally incorporated companies may be jointly assessed.

Tax rates are highly variable. Some systems apply higher rates to larger incomes. Rate schedules for individuals can differ based on marital status. [b] For instance, in India, a slab rate system is in place: income below INR 2.5 lakhs annually is taxed at 0%, income between INR 2,50,001 and INR 5,00,000 is taxed at 5%, with rates increasing progressively up to 30% for incomes exceeding INR 15,00,000.

Residents and Non-residents

Residents and non-residents are generally taxed differently. Few jurisdictions tax non-residents on anything other than specific types of income earned within their borders. See, for example, the taxation of foreign persons in the United States. Residents, conversely, are typically liable for income tax on their entire worldwide income. [c] A small number of jurisdictions, notably Singapore and Hong Kong, tax residents only on income earned within or remitted to the jurisdiction. Situations can arise where a taxpayer owes tax in their country of residence and also in another country where they are considered a non-resident. This leads to double taxation, which is often addressed through Double Taxation Avoidance Agreements negotiated between the relevant jurisdictions.

An individual's residence status is often determined by physical presence in the jurisdiction for more than 183 days. For entities, residence is typically based on the place of organization or management and control.

Defining Income

Most systems adopt a broad definition of income subject to tax for residents, while limiting taxation for non-residents to specific income types. The definition of what constitutes income for individuals may differ from that for entities. The timing of income recognition can also vary based on the taxpayer type or income category.

Income generally encompasses most forms of receipts that benefit the taxpayer, including compensation for services, gains from selling goods or other property, interest, dividends, rents, royalties, annuities, pensions, and a wide array of other sources. [d] Many systems exclude, in whole or in part, payments from superannuation or other national retirement plans. Similarly, most tax systems exclude employer-provided or national insurance-based health care benefits from taxable income.

Deductions Allowed

Virtually all income tax systems permit residents to reduce their gross income by business and certain other deductions. Non-residents, on the other hand, are typically taxed on the gross amount of most income types, plus any net business income earned within the jurisdiction.

Expenses incurred in trade, business, rental activities, or other income-producing endeavors are generally deductible, although limitations may apply to certain types of expenses or activities. Business expenses encompass all costs deemed beneficial to the activity. An allowance for the recovery of the costs of assets used in the business, often termed a capital allowance or depreciation deduction, is almost always permitted. The rules governing capital allowances vary significantly, often allowing for the recovery of costs more rapidly than over the asset's useful life.

Most systems provide individuals with some form of notional deductions or a tax-exempt amount. Furthermore, many systems allow for the deduction of specific personal expenses, such as home mortgage interest or medical costs.

Business Profits

With few exceptions, only the net income generated from business activities, whether by individuals or entities, is subject to taxation. Many countries require businesses to prepare audited financial statements. [44] In such countries, taxable income is often defined as the income reported in these financial statements, with minimal adjustments. A few jurisdictions employ a simplified method for certain businesses, particularly branches of non-residents, calculating net income as a fixed percentage of gross revenues.

Credits

Nearly all systems grant residents a credit for income taxes paid to other jurisdictions on similar income. For instance, a credit is typically allowed at the national level for income taxes paid to foreign countries. Many income tax systems also offer various other credits, often unique to the specific jurisdiction.

Alternative Taxes

Certain jurisdictions, most notably the United States and many of its states, as well as Switzerland, impose the higher of the regular income tax or an alternative tax. Switzerland and US states generally apply such taxes only to corporations and base them on capital or a comparable measure.

Administration

Income tax is typically collected through one of two primary methods: withholding of tax at the source of payment, and/or direct payments made by taxpayers. Almost all jurisdictions mandate that those paying employees or non-residents withhold income tax from such payments. The amount withheld is often a fixed percentage, corresponding to a fixed tax rate. Alternatively, the tax administration, or the payer using prescribed formulas, may determine the amount to be withheld. Payees are generally expected to provide the necessary information to the payer or government for these calculations. Withholding for employees is frequently referred to as "pay as you earn" (PAYE) or "pay as you go."

Income taxes for workers are often collected by employers through a withholding or pay-as-you-earn tax system. These collected amounts are not necessarily the final tax liability, as workers may be required to consolidate wage income with other income and/or deductions to determine their actual tax due. The calculation of withheld tax can be managed by the government or by employers, utilizing withholding allowances or specific formulas.

Nearly all systems require individuals whose tax liability is not fully satisfied through withholding to self-assess their tax and remit payments either before or concurrently with the final determination of their tax obligation. Self-assessment involves the taxpayer calculating their tax liability and submitting this computation to the government. Some countries provide taxpayers with a pre-calculated tax estimate, which they can then amend as necessary.

The voluntary compliance rate, representing the proportion of individuals who pay their income taxes in full and on time without penalties or government intervention, is notably higher in the US than in countries like Germany or Italy. [45] In nations with a substantial black market, this rate is considerably lower and may be practically impossible to calculate accurately. [45]

State, Provincial, and Local

In countries with federal systems, sub-national jurisdictions often impose their own income taxes. This is the case in Canada, Germany, Switzerland, and the United States, where provinces, cantons, or states levy separate taxes. In a few countries, cities also impose income taxes. The system may be integrated, as in Germany, with taxes collected at the federal level. In Quebec and the United States, federal and state systems are administered independently and may have differing rules for determining taxable income.

Wage-Based Taxes

Retirement-oriented taxes, such as Social Security or national insurance, are also a form of income tax, though not typically referred to as such. In the US, these taxes are generally levied at a fixed rate on wages or self-employment earnings up to a specified annual maximum. The tax burden can fall on the employer, the employee, or both, potentially at different rates.

Some jurisdictions also impose taxes collected from employers to fund unemployment insurance, healthcare, or similar governmental programs.

Economic and Policy Aspects

Multiple, often conflicting, theories exist regarding the economic impact of income taxes. [e] Income taxes are widely perceived as a progressive tax, meaning the tax burden increases as income rises.

Effect on Labour Supply

Some research suggests that income taxes have a minimal impact on the total hours worked. [46] However, more recent studies indicate a significant price elasticity of supply due to reductions in labour force participation rates and human capital investment.

The increased costs associated with labour and capital imposed by income tax create deadweight loss within an economy. This represents a loss of economic activity resulting from individuals choosing not to invest capital or engage in productive work due to the perceived tax burden. Additionally, resources are diverted as individuals and professionals dedicate time to tax-avoidance strategies rather than economically productive pursuits. [48]

Tax Avoidance

Tax avoidance strategies and loopholes are an inevitable feature of income tax codes. Taxpayers discover legal methods to minimize their tax obligations, prompting lawmakers to close these loopholes with new legislation. This creates a vicious cycle of increasingly complex avoidance strategies and counter-legislation. [49] This cycle disproportionately benefits large corporations and wealthy individuals who can afford the specialized professional advice required for sophisticated tax planning, [50] thereby challenging the notion that even a marginal income tax system can be truly progressive.

Bracket Creep

Bracket creep generally refers to the phenomenon where inflation pushes nominal wages and salaries into higher tax brackets, resulting in fiscal drag. [51] [52] [53] However, even within a single tax bracket, or if one remains within the same bracket, inflation can still lead to bracket creep, increasing the proportion of income paid in taxes. While the marginal tax rate might remain constant, the average tax rate will rise.

Most progressive tax systems are not indexed for inflation. As wages and salaries increase nominally due to inflation, they are taxed at higher rates, even if their real value has not changed. Consequently, taxes increase in real terms unless tax rates or brackets are adjusted accordingly.

Types of Income

The types of income subject to income tax are numerous and highly variable, depending on the specific country and its tax laws. Generally, countries tax income derived from wages, salaries, interest, dividends, and rental income. [54] Wages and salaries are the most common forms of taxable income, often subject to employer withholding. One-time payments like bonuses are also typically taxable. Dividends and interest from stocks or bonds are usually taxed as well. [55]

There is considerable variation in taxation levels across countries. For example, countries such as Singapore, Belgium, and the United Arab Emirates impose low income taxes on interest and dividends, whereas Denmark, France, and the United States levy significantly higher taxes on this type of income. Capital gains, arising from the sale of assets or real estate, are taxed differently across countries and distinct from other income types. Rental income may also be taxed, though many countries offer deductions or exemptions for it. [56]

Around the World

Income taxes are a feature of most countries globally. Tax systems differ significantly, employing flat fixed rates, progressive, or regressive structures depending on the tax type. Comparing tax rates across countries is a complex and often subjective endeavor. Tax laws are intricate, and the tax burden is distributed unevenly among different groups within each country and its subdivisions. Furthermore, the quality and scope of government services provided in return for taxation vary widely, complicating comparisons.

Countries that tax income generally adopt one of two main systems: territorial or residential. Under a territorial system, only income sourced within the country is taxed. In a residential system, tax residents are taxed on their worldwide income (both local and foreign), while non-residents are taxed only on their local income. A small minority of countries, notably the United States, also tax their non-resident citizens on their worldwide income.

Countries employing a residential system typically allow deductions or credits for income taxes already paid to other countries on foreign earnings. Many nations also enter into tax treaties to prevent or mitigate double taxation.

The taxation systems for individuals and corporations are not always uniform. For instance, France utilizes a residential system for individuals but a territorial system for corporations, [57] while Singapore employs the opposite approach, [58] and Brunei taxes corporate income but not personal income. [59]

Transparency and Public Disclosure

Public disclosure of personal income tax filings is practiced in Finland, Norway, and Sweden (as observed in the late 2000s and early 2010s). [60] [61] In Sweden, this information has been published annually in the directory Taxeringskalendern since 1905.

There. A thorough excavation of the topic, complete with the expected historical detours and bureaucratic jargon. It’s all there: the mechanisms, the rationales, the historical precedents. And, of course, the inherent complexities and inequalities that such systems inevitably generate. It’s a well-documented, if rather dreary, aspect of human civilization. Now, if you’ll excuse me, I have more pressing matters to attend to than the minutiae of government revenue extraction.