In my last post we discussed the basis in law for our taxation system. The Sixteenth Amendment gives Congress the ability to levy income taxes “from whatever source derived”. The Department of Treasury and its subsidiary, the Internal Revenue Service, are responsible for enforcing the tax laws, making administrative law (if asked by congress) and collecting income taxes. The IRS is, therefore, a law enforcement agency.
The US tax system like most developed countries in the world, is a progressive tax system. A progressive tax takes a larger percentage of income from high-income groups than from low-income groups and is based on the concept of ability to pay. A progressive tax system might, for example, tax low-income taxpayers at 10 percent, middle-income taxpayers at 12 percent and high-income taxpayers at 37 percent. Below is an example of the taxes an employee will pay on their income with the progressive tax system.
Let’s say that Jane works as an employee for a business and makes a salary of $65,000 a year. This is how Jane’s salary will be taxed under the current US progressive tax system:
- First Jane will pay Social Security and Medicare tax of 7.65% of her overall income. This breaks down to 6.2% social security tax and 1.45% for Medicare tax. Her employer will pay an equal amount to the IRS. The social security tax is levied on all employees first $142,800 of income. There is no income limit for Medicare tax. This is $65,000* 7.65%= $4,972.50 for the year for Jane.
- The tax law has many deductions from income that a taxpayer can use to reduce their taxable income or if these don’t apply to your situation then the tax code gives each taxpayer a standard deduction. Jane is single, so the standard deduction for a single taxpayer is $12,550. Janes taxable income under our tax system is ($65,000- $12,550) = $52,450.
- We now look to the progressive tax schedule to determine Jane’s tax liability. Here are the three federal brackets that apply to Jane: 10%- $0-$9,950; 12%- $9,951-$40,525; 22%- $40,526-$81,050. Remember that Jane’s taxable income after the standard deduction is $52,450 so we plug this income into appropriate brackets to calculate her tax liability for the year. Janes federal taxable income is 10%($9,950)+ 12%($30,575)+ 22%($11,925) or $995+ $3,669+ $2,623= $7,287.50
- Jane also needs to pay state tax as well. All states have their own tax systems some progressive and some have flat rates. Jane lives in Georgia so she is responsible for Georgia state income tax. Georgia has passed a flat tax through the state House and it’s expected to pass the Senate and become law. The flat tax rate is 5.375% of taxable income. In Jane’s case the calculation for state tax is $52,450* 5.375%= $2,819.
- Jane, like all employees is responsible for paying social security and Medicare tax as well as Federal and state income taxes. Her after tax money she can use to pay bills during the year and live is $65,000- ($4,972.50 social security and Medicare Tax - $7,287.50 Federal tax liability – $2,819 Georgia state income tax). That’s $65,000- $15,079 total tax= $49,921 after all tax paid or $4,160 a month.
This is a simple example of how the progressive tax system works within our US tax system. Jane made $65,000 but had to pay taxes to her lifelong business partners. She had to contribute to social security and Medicare, the federal government as well as her state government in Georgia. “There is no free lunch” and “taxes are as inevitable as death” are two truisms in our lives as citizens.