Types of Taxes and Who Collects Them
You just got your first paycheck from a part-time job. You expected $\$600$, but the amount on the check is smaller. Where did the rest go, who got it, and what does it pay for? By the end of this page you will be able to answer all three questions.
Three levels of government, four main taxes
In the United States, three levels of government collect taxes: federal (the whole country), state, and local (cities, counties, school districts). Each one needs money to provide services.
Four taxes cover most of what a typical person pays:
| Tax | Who pays it and when | Mainly collected by |
|---|---|---|
| Income tax | On what you earn | Federal (IRS); most states too |
| Payroll tax (FICA) | Taken out of each paycheck | Federal |
| Sales tax | Added at the register when you buy | State and local |
| Property tax | Owners of homes and land, once a year | Local (county, city, school district) |
Some states have no income tax (Texas, Florida, and Washington, for example). Some states have no state sales tax. Rules differ, so always check your own state.
For each tax, say whether it is mainly collected by the federal, state, or local government (some can have more than one answer): (a) federal income tax; (b) FICA…
For each tax, say whether it is mainly collected by the federal, state, or local government (some can have more than one answer):
(a) federal income tax;
(b) FICA payroll tax (Social Security and Medicare);
(c) sales tax at the register;
(d) property tax on a home.
Sales tax: added at the register
The price on the tag does not include sales tax. The register adds it. Many places combine a state rate and a local rate.
$$\text{sales tax} = \text{price} \times \text{rate}, \qquad \text{total} = \text{price} + \text{sales tax}$$Why does this work? A 7% rate means 7 cents for every dollar, so you multiply the price by $0.07$.
Noah buys sneakers priced at $\$80$. The sales tax rate is 7%. Calculate the sales tax and the total he pays at the register.
Noah buys sneakers priced at $\$80$. The sales tax rate is 7%. Calculate the sales tax and the total he pays at the register.
Isabella buys a laptop bag and accessories for $\$240…
Isabella buys a laptop bag and accessories for $\$240$ before tax. The state sales tax is 6%, and the city adds a local sales tax of 1.5%.
(a) Calculate the combined tax rate and the total tax.
(b) How much goes to the state and how much to the city?
(c) What is the final price she pays?
Payroll and income taxes: what comes out of your paycheck
Your gross pay is what you earn before anything is taken out. Your net pay (take-home pay) is what you actually receive.
FICA is the federal payroll tax. It has two parts, and the employee pays:
-
Social Security: $6.2\%$ of gross pay
-
Medicare: $1.45\%$ of gross pay
-
Total: $7.65\%$
Your employer also pays a matching amount. FICA funds retirement, disability, and health benefits for older Americans.
Income tax is withheld too. The federal government always takes some, and most states do as well.
$$\text{net pay} = \text{gross pay} - \text{FICA} - \text{federal income tax} - \text{state income tax}$$Emma earns $\$1{,}800…
Emma earns $\$1{,}800$ gross every two weeks. Her employer withholds FICA (6.2% for Social Security and 1.45% for Medicare) and 10% of her gross for federal income tax. Her state has no income tax.
(a) Calculate the Social Security tax, the Medicare tax, and the total FICA.
(b) Calculate the federal income tax withheld.
(c) Calculate her net pay for the period.
Property tax and what taxes pay for
Property tax is paid by owners of homes and land, usually once or twice a year to the county or city. The amount is based on the assessed value of the property.
$$\text{property tax} = \text{assessed value} \times \text{rate}$$Renters pay it indirectly, because landlords often build it into the rent.
Taxes pay for services you use every day:
| Revenue source | Commonly pays for |
|---|---|
| Local property taxes | Public schools, police, fire, local roads |
| FICA payroll taxes | Social Security and Medicare benefits |
| Federal gas taxes | Highways and bridges |
| Sales and income taxes | State services, colleges, parks, Medicaid |
Some payments are transfer payments: money the government collects and passes to people, such as Social Security checks or unemployment benefits.
Match each tax revenue source to a public service it commonly helps pay for: (a) local property taxes; (b) FICA payroll taxes; (c) federal gas taxes. Services: public…
Match each tax revenue source to a public service it commonly helps pay for:
(a) local property taxes;
(b) FICA payroll taxes;
(c) federal gas taxes.
Services: public schools; highways; Social Security and Medicare benefits.
A home in a Houston suburb has an assessed value of $\$250{,}000…
A home in a Houston suburb has an assessed value of $\$250{,}000$. The local property tax rate is 1.2% of assessed value per year.
(a) Calculate the yearly property tax.
(b) Calculate the monthly amount a homeowner should set aside.
(c) Which level of government usually receives this tax, and what does it commonly pay for?
Comparing taxes and thinking critically
Taxes can be compared by how much of a person's income they take. A sales tax takes the same rate from everyone's purchases, but people with lower incomes spend a larger share of their income, so sales tax can take a larger share of their income. Income tax usually takes a larger share as income rises.
Daniel earns $\$40{,}000$ a year and spends $\$22{,}000$ a year on items subject to sales tax. He is comparing two hypothetical states. State A: no state income tax, 8%…
Daniel earns $\$40{,}000$ a year and spends $\$22{,}000$ a year on items subject to sales tax. He is comparing two hypothetical states.
-
State A: no state income tax, 8% sales tax.
-
State B: 4% state income tax (applied to all of his income to keep things simple), 5% sales tax.
(a) Calculate his yearly state income tax plus sales tax in each state.
(b) Which state costs him less in these two taxes?
(c) Argue why this comparison alone is not enough to decide where to live, for example by considering property taxes, services, and who spends a larger share of income.
A town has 4,000 homes with an average assessed value of $\$200{,}000$. The property tax rate is 1.5%. The town budget is $\$12{,}000{,}000$: schools $\$7{,}500{,}000…
A town has 4,000 homes with an average assessed value of $\$200{,}000$. The property tax rate is 1.5%. The town budget is $\$12{,}000{,}000$: schools $\$7{,}500{,}000$, police and fire $\$3{,}000{,}000$, roads $\$1{,}500{,}000$.
(a) Calculate the revenue the property tax raises and show it matches the budget.
(b) Voters want $\$1{,}800{,}000$ more for schools. Calculate the new rate needed and the extra yearly tax on the average home.
(c) Argue for or against the increase, describing benefits of the tax revenue and costs to households.
Summary
Back to the start: your paycheck was smaller than $\$600$ because FICA, federal income tax, and possibly state income tax were withheld before you were paid. That money funds retirement benefits, roads, schools, and more.