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Taxes and Government Spending
Taxes are a part of almost every financial decision, from buying a snack to earning a paycheque. They fund schools, roads, healthcare and many other services. Understanding taxes helps you plan your finances and take part in public debates about how taxes should work. In this lesson you will learn about different types of taxes and how progressive income taxes are calculated.
Why governments collect taxes
Governments use tax revenue to pay for public goods and services, such as:
- schools and universities
- roads, bridges and public transport
- police, courts and defence
- healthcare and public health
- pensions and support for people who are unemployed, sick or disabled
How much to tax, who should pay and what to spend money on are some of the most debated questions in politics. People reasonably disagree about these choices.
Types of taxes
| Tax | What is taxed | Example |
|---|---|---|
| Income tax | money earned from work and investments | deducted from wages |
| Sales tax or VAT | spending on goods and services | added to the price at the till, or included in it |
| Property tax | the value of property, such as homes and land | paid by homeowners, often to local government |
| Corporate tax | business profits | paid by companies |
| Excise tax | specific products | fuel, tobacco, alcohol |
Sales tax and VAT
In some countries, such as the United States, sales tax is usually added at the checkout, so the price on the shelf is not the final price. In many other countries, value-added tax (VAT) or goods and services tax is already included in the displayed price.
Progressive, proportional and regressive
- A progressive tax takes a higher percentage from higher incomes. Many countries’ income taxes are progressive.
- A proportional (flat) tax takes the same percentage from everyone.
- A regressive tax takes a higher percentage of income from people with lower incomes, even if the rate is the same. Sales taxes can be regressive, because lower-income households spend a larger share of their income.
How tax brackets really work
Many people misunderstand tax brackets. In a progressive system, income is divided into bands, and each band is taxed at its own rate. Moving into a higher bracket does not mean all your income is taxed at the higher rate.
Worked example (fictional country)
Imagine a country with these yearly income tax brackets:
| Income band | Tax rate |
|---|---|
| 0 to 10,000 | 0% |
| 10,001 to 40,000 | 10% |
| Above 40,000 | 20% |
Jordan earns 50,000 per year. Tax is calculated band by band:
- First 10,000: 10,000 × 0% = 0
- Next 30,000 (from 10,001 to 40,000): 30,000 × 10% = 3,000
- Final 10,000 (above 40,000): 10,000 × 20% = 2,000
- Total tax: 0 + 3,000 + 2,000 = 5,000
Marginal and effective tax rates
- Jordan’s marginal tax rate, the rate on the last unit of income, is 20%.
- Jordan’s effective tax rate, total tax divided by total income, is 5,000 ÷ 50,000 = 10%.
A common myth
Some people believe a pay rise could leave them worse off because it “pushes them into a higher bracket”. In a system like this, only the income above the bracket threshold is taxed at the higher rate, so a pay rise still increases take-home income. (Other effects, such as losing eligibility for certain benefits, can sometimes complicate this, so it is worth checking the specific rules where you live.)
Filing taxes
In some countries, many workers must file a yearly tax return to report income and calculate whether they owe more tax or are owed a refund. In others, tax is usually settled automatically through payroll. Keep records of your income and any relevant receipts, and use official government guidance or a qualified professional for help.
Thinking critically about tax debates
Debates about tax often involve trade-offs between goals such as fairness, simplicity, economic growth and funding public services. When you hear a claim like “this tax cut will pay for itself” or “this tax will only affect the very rich”, ask what evidence supports it, which independent economists have analysed it, and who gains or loses. Reasonable people weigh these trade-offs differently. Understanding the arguments on several sides helps you form your own informed view and discuss it respectfully.
Key takeaways
- Taxes fund public services, and people debate how they should be designed.
- Main types include income, sales or VAT, property, corporate and excise taxes.
- In progressive systems, each income band is taxed at its own rate.
- The marginal rate applies to the last unit of income; the effective rate is total tax divided by income.
Practice
Using the fictional brackets above, calculate the total tax and effective tax rate for someone earning 30,000.
Answer: first 10,000 at 0% = 0; the next 20,000 at 10% = 2,000; total tax = 2,000. Effective tax rate = 2,000 ÷ 30,000 ≈ 6.7%. Their marginal rate is 10%.