WTT - What the Tax? (Pt.1): Basics

If there is one topic that tops the list of every young adult's list of "how does this work," it's taxes. They are the pinnacle of adulthood, but many of us truly know what they are and why we pay them every year.

So I'm going to do a rather shallow dive into the world of taxes to try to help you, my fellow young adults, understand them a little bit better. This is part 1 of the Guide's newest series: "WTT - What the tax?"

An important note is that the information below is referring to the American system of taxes. I don't presume to be an expert, so I'll be relying on credible sources of information for the details.

What are taxes?

Deep breath.

Taxes are a source of income for the state and federal governments. As the American economy is based on a free enterprise system, they need to make money from somewhere and do so from income, sales and property taxes.

This income then funds public services, such as national defense, infrastructure, education or natural resource management. Not only are these kinds of services considered more efficiently managed by the government, but they also cover some services not otherwise provided by the free enterprise system.

So, in very brief summary, we fund these services through the taxes that we pay.

Types of taxes

There are three main sources from which taxes are collected in the US: income, consumption and wealth.¹

Income

In an attempt to keep this short, I'm going to talk about the main type of income taxes in the US based on relevance to you. If you want an exhaustive list, I suggest you check out the table provided by the IRS.

One type of income tax that anyone with a job has been subject to is that wages, salaries and tips income tax. When you earn money working at your job, that company will provide you with a W-2 form, normally in January, detailing how much you made while in their employment, as well as any tax withholdings. 

Any W-2s provided to you (one per job that you have) will be submitted in your tax return so that the government can collect the appropriate taxes.

More information on specific forms will be outlined in upcoming articles in this series.

Consumption

This kind of tax is that which is applied to a good or service and can take the form of sales taxes, tariffs, and excise.²

Each state has its own set of tax rates and taxable goods or, for example in Delaware, can decided to not levy sales taxes at all. States earn a large part of their revenue from sales tax but they can also use taxes as instruments for spending.

In this case, excise taxes, also known as "luxury taxes," are used by the state and federal governments as a way to either deter purchase by the consumer or place a certain burden on the consumer based on the service/good. Gas is normally subject to an excise tax, paid by people who fill up their cars, which pays for things such as highway maintenance or mass transit systems.

Alcohol and tobacco are also subject to excise taxes to deter people from buying these potentially harmful products.

What next...?

Next up in this series is a post all about how to pay your taxes using all of the methods out there available to you! I'll also go into more details about the different forms and IRS information that may be helpful for your first filing.

Important terminology

1. free enterprise system - this economic system is based on consumers being free to decide how to spend or invest their money. Producers create or sell their goods based on demand and products are improved in quality and cheaper based on open competition among producers. 
2. infrastructure - infrastructure is the basic physical systems of a business or nation; transportation, communication, sewage, water and electric systems are all examples of infrastructure.³
3. income - money that an individual or business receives in exchange for providing a good or service or through investing capital.⁴

Final Notes

Whew... so there you go: an introduction to taxes! I hope that you found this useful and informative in your quest for adulthood. As mentioned, this is the first in a series, so keep an eye out for more articles on this subject coming up in the coming month.

In the meantime, feel free to reach out in the comments below or via Twitter in case you have any questions.

Thanks!

References

¹US Treasury
²Investopedia
³Investopedia
⁴Investopedia