Taxation principles are the guidelines used to establish and collect taxes in such a way as to make the process equitable across the spectrum of those they are collected from. In other words, in a perfect system, individuals would be taxed based on their ability to pay. Those with higher incomes would pay more in taxes than those with lower incomes.
Today, there are two essential principles of taxation used by the IRS. The first is that in the U.S. income taxes are considered progressive. The second is that taxes are based on the individual taxpayer’s ability to pay. But, there is more to this than meets the eye, as not all forms of progressive taxation are as successful as they could be.
The theory behind this particular principle of taxation is that progressive taxes require those with higher incomes to pay a larger share of the total taxes collected. In turn, this means those at the lower end of the scale would pay less in taxes. But in order for this type of taxation to succeed, the tax percentage rate would increase as the person’s income increased until it reached the pre-established cap to ensure no one ends up paying more than their “fair” share.
One thing the idea of progressive taxes often fails to account for is that those at the top of the income level scale have access to significantly more ways of investing their income to reduce the amount of taxes they must pay. Unfortunately, those at the bottom of the income scale usually lack the ability or resources to take advantage of these same loopholes. In the end, it is possible that low to middle-income individuals end up paying a larger percentage of their income in taxes because of this.
However, the fact that these individuals may pay a larger percentage of their income in taxes doesn’t necessarily mean they are paying more in actual dollars. What it does mean is that $3000 in taxes to a person who only earns $30,000 equates to paying 10% in taxes, but to the person who earns $3 million in income, this same amount only represents a mere 0.001% of their income.
Hence the principle of progressive taxation in that the person with a $3 million income would be asked to pay a much higher percentage to ensure that everyone pays their fair share. The perfect system would include several different tax rates to ensure that each taxpayer possesses the ability to pay, which leads to the other principle of taxation.
The ability-to-pay taxation principle takes into account each taxpayer’s ability to make said tax payments. This entire principle hinges on the ideology that people should be taxed based on their ability to pay. Both principles of progressive taxation and the ability-to-pay are tied together in order to create a working tax system. The base idea behind this principle is that a fair tax system should base its taxes such that those who have varying amounts of wealth and/or income should pay taxes at varying rates based on this information.
Income is defined as wages, dividends, interest, and other income in the form of payments. Wealth is defined as assets including; cars, houses, property, savings accounts, stocks, and bonds. While each of these can generate its own income when sold, taxes are often paid only after the asset in question is sold.
A progressive taxation, such as the system used in the United States and collected by the IRS, is thought to be a good taxation method and, in principle, it is. Many other countries use a flat tax system in which everyone pays a set rate or percentage of taxes based on their income. There are no deductions and no loopholes. The taxpayers simply calculate how much their taxes are based on a given percentage and pay their taxes. There is also another form of progressive taxation in which the percentage increases along with the individual’s income or ability to pay. To date, these principles of taxation are considered to be among the fairest in the world.