U.S. Tax System: The Concept, the Math, and the Controversy

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Written by Ada Wong from Toronto, Canada

What is “Tax?”

Taxation is the imposition of mandatory payments from individuals or companies to the

government. Most, if not all countries in the world have their own tax policies. Usually, higher

tax rates imply better social benefits, since the higher tax a government collects, the more money there is for the government to build public goods and services (for instance, public

transportation, public schools, universal healthcare, etc.). When a government spends more than the amount of tax they collected as revenue, that government experiences a government deficit.

For example, the government deficit of the United States is estimated to be around $475 billion in the first five months of the fiscal year 2022, according to the Congressional Budget Office. To visualize the purchasing power of $475 billion, it is more money than the entire GDP of many countries, even developed ones, including Austria, Ireland, Singapore, and Switzerland.

The current U.S. Tax System

The United States has two levels of taxes, federal and state, that are completely

independent of each other, i.e. they cannot interfere with each other’s tax policies. Most

independent/individual taxes come down to two types: income tax and sales tax.

In short, income tax is paid as a percentage of each dollar earned. In most cases, the

income one receives is one that already has its tax deducted. It is mandatory for those who earn over $6,750 to file both federal and state taxes by the 15th of April every year.

Sales taxes, however, apply to the money one spends, rather than earned. This tax mostly

varies by state. For example, the sales tax in California is 7.25% while in Texas it’s 6.25%.

The United States is currently under a progressive tax system, which increases tax rates

as the taxable income of one increases; in other words, the amount of tax is determined by the ability that one can pay. Taxpayers are grouped by tax brackets, and they are charged only 10% for their first $10,275 earned. Starting from their 10,276th dollar, each additional dollar will be charged 12%.

For example, if A earns $10,000 in 2022:
    A would pay:
        ($10,000)×(10%) = $1,000 of tax

If B earns $50,000 in 2022:
    B would pay:
        ($10,275)×(10%)+($31,500)×(12%)+($8,225)×(22%) = $6,617 of     tax


This is because B has $10,275 in the 10% bracket (first $0 ~ $10,000 annual income),
$31,000 in the 12% bracket ($10,276th to the $41,775th annual income), and $8,225 in the 22%
bracket ($41,776 to $89,075).

The full chart for the 2022 brackets is here: (Clarine)

Advantages

As mentioned before, the tax rate increases for each additional dollar of income. This

means more tax can be collected while maintaining a basic quality of life for low-income

populations. This also means that the richer people tend to pay more taxes than those with low income. In 2019, the top 1 percent paid a greater share of individual income taxes (38.8% of total U.S. income taxes) than the bottom 90 percent combined (29.2% of U.S. income taxes) (York).

The progressive tax system is also able to do all this without discouraging people to get

promoted. In many tax systems, the brackets are based on total income rather than marginal

income. This makes people afraid of being promoted as if their new position doesn’t offer them more salary than the tax they will be charged, they are actually earning less.

    For example. If country A taxes people based on total income, $10,001 to $20,000 is ten-percent and $20,001 to $30,000 twenty-percent, then one may not want to get promoted from a job with $19,000 salary to one with $20,020 since the increase in income is

        (20,020-19,000)÷19,000 = 5.37%
    but the increase in tax paid is
        (20,020*20% - 19000*10%)÷(19000*10%) = 110.74%

Disadvantages

As much as the system seems to work out, there are also people who think the system is

at its own disadvantages.

Many find it ironic that the rich are actually not able to enjoy each additional dollar of their labour/work more. According to Kagan, “critics of progressive taxes consider them to be a disincentive to success. They also oppose the system as a means of income redistribution, which they believe punishes the rich, and even the middle class, unfairly.” After all, as mentioned before, the top 1% wealthy people pay more taxes than the bottom 90% combined.

It is possible, however, to consider resolving the debates by 1) decreasing the tax rates of the middle income brackets and/or 2) educating the public on the difference between marginal (for each additional) vs. total (the entire) and how the progressive tax system actually taxes.