A tax is a compulsory financial charge levied by the government on individuals, legal entities and/or property to support the collective costs of public goods, services, and activities and reduce negative externalities. The levy may be in the form of a flat percentage rate of personal annual income or a scaled system of brackets on yearly income amounts. Many systems also allow for personal allowances and reductions of taxable income. Governments also levy taxes on corporations, payrolls, sales, use, wealth, estate and inheritance taxes, and a variety of duties, tariffs and excise taxes.
Understanding how and why governments impose tax is a critical aspect of microeconomics. The goals of taxation are usually described as resource allocation, redistribution of income, and economic stability (or economic growth or development). Ideally, the government will not interfere in market-determined allocations unless there is a compelling reason to do so.
Federal income taxes are based on a taxpayer’s taxable income, which is calculated by adding all sources of earned income and subtracting the standard deduction. State taxes vary widely, and can be based on a percentage of sales value (ad valorem), a fixed amount per unit, or even a flat fee per activity. Other types of governmental taxation include environmental taxes, property taxes (e.g., on real estate, tangible personal property, and automobiles), payroll taxes, consumption taxes (e.g., on gasoline and tobacco), and excise taxes. Having a big-picture idea of how taxation works can help you make the most of your finances and position yourself for greater tax efficiency.