Tax Bases Anderson: Structure of Taxes

What is Taxed? Defining the Tax Base The tax base reflects what is taxed, and therefore what is not taxed as well. Copyright © by Houghton Mifflin Company. All rights reserved.2

Haig-Simons Definition of Taxable Income Income during a particular period of time includes consumption plus the change in a person’s net worth Consumption or change in potential future consumption Net measure, it requires that the costs of earning income be subtracted Blind to the source of income. It doesn’t matter whether income is due to capital or labor Should include imputed income All accretion to wealth should be included, whether it is regular or fluctuating, expected or unexpected, realized or unrealized. No consideration should be given to how the income is used, i.e. whether it is saved or consumed Copyright © by Houghton Mifflin Company. All rights reserved.3

Basic Personal Income Tax Calculations Jack has gross income of $60,000, from which he subtracts some deductions to get adjusted gross income (AGI). From AGI, he subtracts his family exemptions and either the standard deduction or itemized deductions (Jack chooses the former), yielding taxable income. A tax schedule is applied to determine taxes owed, and tax credits are then subtracted to arrive at the final tax payment.

Computing the Tax Base gross income The total of an individual’s various sources of income. adjusted gross income (AGI) An individual’s gross income minus certain deductions Structure of the Individual Income Tax in the United States

Examples of Deductions between Gross Income and Adjusted Gross Income These adjustments have varied over time, but as of 2009 they include:  Contributions to retirement savings through IRAs or self- employed pension plans.  Alimony paid to a former spouse.  Health insurance premiums paid by the self-employed.  One-half the payroll taxes paid by the self-employed.  Educator expenses.  Contributions to Health Savings Accounts.  Expenses for job-related moves.  Interest paid on student loans.

exemption A fixed amount a taxpayer can subtract from AGI for each dependent member of the household, as well as for the taxpayer and the taxpayer’s spouse. Structure of the Individual Income Tax in the United States Computing the Tax Base

standard deduction Fixed amount that a taxpayer can deduct from taxable income. itemized deductions Alternative to the standard deduction, whereby a taxpayer deducts the total amount of money spent on various expenses, such as gifts to charity and interest on home mortgages. Structure of the Individual Income Tax in the United States Computing the Tax Base There are two forms of deductions from which to choose:

Structure of the Individual Income Tax in the United States Computing the Tax Base Under the itemized deductions route, the taxpayer deducts from his or her income the sum of amounts from several categories:  Medical and dental expenses exceeding 7.5% of AGI.  Other taxes paid, such as state or local income tax (or sales tax if the state has no income tax), real estate tax, and personal property tax.  Interest the taxpayer pays on investments and home mortgages.  Gifts to charity.  Casualty and theft losses.  Unreimbursed employee expenses, such as union dues or expenses incurred on job travel. taxable income The amount of income left after subtracting exemptions and deductions from adjusted gross income.

Structure of the Individual Income Tax in the United States Tax Rates and Taxes Paid tax credits Amounts by which taxpayers are allowed to reduce the taxes they owe to the government through spending, for example, on child care. withholding The subtraction of estimated taxes owed directly from a worker’s earnings. refund The difference between the amount withheld from a worker’s earnings and the taxes owed if the former is higher.

Basic Personal Income Tax Calculations Jack has gross income of $60,000, from which he subtracts some deductions to get adjusted gross income (AGI). From AGI, he subtracts his family exemptions and either the standard deduction or itemized deductions (Jack chooses the former), yielding taxable income. A tax schedule is applied to determine taxes owed, and tax credits are then subtracted to arrive at the final tax payment.