alternative minimum tax (AMT)
A provision in the tax code that requires certain individuals
and businesses to calculate their taxes two ways and pay the
government the larger of the two amounts. In general, the AMT takes
effect when deductions are "too large" relative to income. This
means that the tax often applies during economic downturns, when
income falls but expenses remain relatively unchanged.
average tax rate
The overall share of income taken by the government. A taxpayer
with $50,000 of income who pays $10,000 in taxes faces an average
tax rate of 20 percent.
capital gains tax
A tax that applies when an asset is sold for more than its
original purchase price. The tax applies to the "gain" that has
occurred, but the taxpayer is not allowed to adjust for
inflation.
charitable contributions deduction
Provision in the current tax code that allows taxpayers to
deduct contributions made to charities which have been granted
special status by the IRS.
consumption tax
Often associated with taxes collected at the cash register, but
any system that does not double-tax savings and investments is a
consumption tax. The flat tax and the "consumed-income" tax
(basically an unlimited individual retirement account) are
consumption-based income taxes.
consumption tax base
A tax system that treats all income equally. All income is
taxed, but only once (though not necessarily at the same rate). In
the case of the income tax, this means that there are no
deductions, and income that is exempt (such as fringe benefits) is
subject to the tax. Conversely, it also means that no income is
taxed more than once, thus precluding capital gains or estate
taxes.
death tax
A form of taxation under which the assets of taxpayers who
accumulate "too much" savings during their lifetime are subject to
a tax upon death. The rate for this tax reaches 50 percent. The
2001 Bush tax cut repeals the death tax in 2010, but the levy
re-appears in 2011.
deductions
Amounts or types of income that can be excluded from taxable
income. In addition to personal exemptions, taxpayers can take
either a standard deduction or itemized deductions, such as home
mortgage interest and charitable contributions.
depreciation
Provision by which, for example, a business that invests $1
million buying a new machine is not allowed to fully deduct that
cost when calculating its taxable income. Instead, it may deduct
only a portion of the cost each year. Depreciation is complex, and
it increases the tax burden on investment.
double taxation
A form of taxation under which any dollar of income is subject
to more than one level of tax. The classic example is income that
is taxed at the corporate level and then taxed again as dividend
income when received by the shareholder. With capital gains taxes
and estate taxes, it is possible for a single dollar of income to
be taxed four times.
estate tax
See death tax.
flat tax
A single-rate tax system. A flat tax and sales tax are
almost identical in that a flat tax imposes one layer of tax when
income is earned and a sales tax imposes one layer of tax when
income is spent. In either case, all income is taxed, but only once
and presumably at a very low rate.
Hall-Rabushka
Robert Hall and Alvin Rabushka, the two economists at Stanford
University who developed the simple and pure flat tax model.
itemized deductions
Write-offs for such expenses as charitable contributions, home
mortgage interest, and state and local income and property taxes. A
taxpayer may not use both itemized deductions and the standard
deduction. Under the current system, more than 70 percent of
taxpayers use the standard deduction.
marginal tax rate
The amount of additional earnings taken by government. The
taxpayer with $50,000 of income may face a 28 percent tax rate on
the next dollar of income earned, even though the average tax rate
for this taxpayer's income is 20 percent. The marginal tax rate
affects incentives to offer additional labor and/or capital to the
economy.
marriage penalty
The many provisions in the tax code that cause married couples
to pay more in taxes than they would pay if they were single and
living together. Graduated tax rates account for the largest share
of the marriage penalty.
mortgage interest deduction
Provision which allows taxpayers who itemize to deduct from
their income each year the money they pay in mortgage interest.
national sales tax
A nationwide tax imposed on final retail sales of goods and
services to the consumer. This tax presumably would apply to all
goods and services and usually is discussed in conjunction with
total repeal of the income tax.
neutrality
A concept which argues that the tax system should not affect
economic decisions. A neutral tax system, for instance, would not
encourage either savings or consumption. Nor would it bias choices
among types of consumption or types of savings.
personal exemption
An amount of income which the taxpayer is allowed to shield
from tax. The current tax code, as well as most proposed reforms,
grants exemptions for each additional dependent member of a
household. This "zero-bracket" amount would increase with family
size.
preferential treatment
Treatment which occurs if certain incomes or activities receive
favoritism. In the case of a sales tax, for instance, a narrow base
would mean that major items like food, shelter, clothing, and
health care are not subject to the tax. Assuming that policymakers
intend to collect a given amount of tax revenue, allowing
preferential treatment for some items usually has the effect of
increasing the tax rate on all other activities.
progressivity
A system under which people with higher incomes must pay a
higher percentage of tax on taxable income. This can occur
because of a "graduated rate structure" that imposes higher
statutory (or marginal) tax rates as income rises. Alternatively,
the tax code can achieve "effective progressivity" by having
a large personal exemption. Under the Armey-Shelby flat tax, for
instance, a family of four making $30,000 pays no income tax (a
zero percent rate), a family of four making $40,000 pays less than
3 percent of their income in taxes, a family of four making $50,000
pays 5.5 percent, and so on until the "effective" rate approaches
17 percent for those with very high incomes (16.94 percent for an
income of $10 million).
savings bias
Double taxation of savings (with some exceptions, such as IRAs)
by the current tax system. Income is taxed the year it is earned,
and if the taxpayer chooses to save, the interest received is
taxed. Income that is consumed, by contrast, escapes additional
taxation. There are two ways to alleviate this anti-savings bias:
tax-deferred or universal front-ended IRA treatment or
yield-exempt, back-ended IRA or municipal bond treatment.
Sixteenth Amendment
An amendment to the U.S. Constitution which, ratified more than
80 years ago, allows the federal government to levy an income tax.
Supporters of replacing the income tax with the national sales tax
or VAT typically call for its repeal.
social engineering
Attempts by politicians to steer behavior by granting tax
breaks or imposing tax penalties.
special-interest groups
Groups that seek favoritism in government policy.
standard deduction
Additional amount of money, similar to the personal exemption
and based on filing status, that non-itemizing taxpayers may shield
from income.
supermajority amendment
A proposed amendment to the U.S. Constitution that would
require a two-thirds vote of both the House and Senate to increase
taxes (either by raising rates or by expanding the amount of income
that is taxable).
supply-side economics
School of thought which holds that taxes affect incentives to
work, save, invest, and take risks.
tax base
What is being taxed, or the activity that bears the burden of
the tax. How a particular tax reform defines the tax base is one of
the most important elements of that reform.
tax credit
Amount of money that can be deducted directly from a taxpayer's
tax liability, and thus is more valuable than a deduction. A $500
credit, for instance, reduces a taxpayer's total bill by $500,
while a $500 deduction simply reduces the taxpayer's taxable income
by that amount. (For a taxpayer in the 15 percent tax bracket, a
$500 deduction produces a tax saving of $75).
individual retirement accounts (IRAs)
Accounts which allow taxpayers to protect savings from double
taxation. With traditional IRAs, income that is saved is free from
tax, but there is a tax levied on principal and interest when the
money is withdrawn (taxing all income only one time). With
back-ended (Roth) IRAs, the income is taxed the year it is earned,
but there is no second layer of tax on any future interest.
tax expenditure
Provisions of law granting preferential tax status on the basis
of how income is earned or spent. The word "expenditure" is used to
highlight the similarity between the use of the tax code to provide
advantages to a select group and the more traditional method of
giving the group a slice of the federal budget. The proper
definition of a tax expenditure, needless to say, would require a
proper definition of the tax base.
tax limitation amendment
See supermajority amendment.
tax shelter
A loophole in the Internal Revenue Code that people use to
lower their tax liability.
value-added tax (VAT)
A form of sales tax under which the tax is levied on the value
to a product that is added at each stage of the production
process.
wealth tax
A tax levied on wealth directly, on changes in the value of
wealth, or on transfers of wealth. Estate taxes and capital gains
taxes are wealth taxes. Assuming that the income used originally to
create the wealth has already been taxed, most wealth taxes are
examples of double taxation.
