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The main families of tax
Chapter 2 of 9 · explanatory only · no rates, thresholds or deadlines
Classifying taxes by what they are levied on: income, payroll, spending, property, transactions and transfers.
Taxes are usually discussed by name, and names are unhelpful: two charges with the same label can work completely differently, and two charges with different labels can be economically identical. A more durable way to read any tax system is to ask what each charge is actually levied on. That question produces a small number of families, and almost every tax in the world sits in one of them.
2.1The families at a glance
| Family | What it is levied on | Who normally hands the money over | Who is likely to bear it |
|---|---|---|---|
| Income tax | Earnings, profits and returns received by a person over a period | The earner, or an employer deducting before payment | The person whose income it is |
| Payroll or social contributions | Wages, usually split between employer and employee | The employer | Largely the employee, through lower wages over time |
| Consumption tax | Spending, either at the final sale or at each stage of production | The seller | The buyer, in the price |
| Property tax | The value or rental worth of land and buildings | The owner or occupier | Owners of the land, whose asset is worth less because of the charge |
| Transaction tax | A specific act: a sale of shares, a transfer of title, a document | The party completing the act | Usually the buyer, sometimes split by market practice |
| Wealth-transfer tax | Gifts and estates passing from one person to another | The estate or the recipient | The people who would otherwise have received the transfer |
2.2Charges on income
An income tax asks what a person or a business received over a period, subtracts what the rules allow them to subtract, and charges the remainder. Nearly all the difficulty lies in those two middle steps. What counts as income? Is a gain on an asset income, or something else? Which costs may be deducted, and in which period? A business buying a machine has plainly spent money, but the machine will still be there next year, so most systems spread the cost over the machine's working life instead of allowing it all at once. That single decision generates a large fraction of all business tax rules.
2.3Charges on wages
Payroll charges are levied on employment specifically, and are often split so that part is billed to the employer and part to the employee. The split is presented as a matter of fairness, but it mostly determines who does the paperwork. Because an employer decides whether a job is worth its total cost, a charge added on the employer's side tends over time to be absorbed in wages that are lower than they would otherwise have been. This is the clearest everyday example of the difference between the legal incidence of a tax and its economic incidence.
2.4Charges on spending
A charge on spending can be collected once, at the final sale to a consumer, or in stages along the chain of production. The staged version, which is what a value-added tax is, works by having each business charge tax on what it sells, reclaim the tax it was charged on what it bought, and pay over the difference. The consumer at the end reclaims nothing, so the whole burden lands there, but the revenue arrives in instalments from every business in the chain.
The design has one large practical advantage: each business has a documentary interest in the stage before it, because it needs an invoice to reclaim its own tax. It has a matching weakness, which is that the reclaim mechanism can be attacked directly by claiming refunds on purchases that never happened.
2.5Charges on property and transactions
Property charges are levied on something that cannot be moved or hidden, which makes them administratively robust and politically difficult in equal measure. Because the amount owed does not depend on whether the property produced any income this year, the charge can fall awkwardly on people who are asset-rich and cash-poor, and every system that uses them wrestles with that.
Transaction taxes are levied on the act rather than the thing: transferring a title, executing a document, buying a security. They are simple to collect, because there is a moment at which someone needs the transaction recognised, and they have one predictable side effect, which is that transactions happen less often. Whether that is a defect or the point depends on which of the four jobs from Chapter 1 the charge was meant to be doing.
2.6Who really pays
The single most useful idea in this chapter is that the person who hands the money over is often not the person who ends up poorer. Economists call the difference tax incidence, and the general rule is that the burden settles on whichever side of a transaction has the fewest alternatives. If customers will buy the product regardless, a charge on the seller mostly reaches the price. If customers will readily go elsewhere, the seller absorbs it. Any claim that a tax is paid by companies rather than people is, at best, a statement about the paperwork.