Types of Taxes and The Jurisdictions That Use Them

Chapter 1
Types of Taxes and the

Jurisdictions that Use Them
1
McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
1-2
Objectives
2
• Define tax, taxpayer, incidence, jurisdiction

• Express the relationship between tax base, rate, and revenue as a
formula
• Describe the taxes levied by local, state, and federal government
• Explain why different jurisdictions compute for revenues from
the same taxpayer
• Identify the reasons why governments modify their tax systems
• Describe the three primary sources of federal tax law
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Basic Terminology
3
• Tax = compulsory payment to support

the cost of government
• contrast with fine/penalty or user fee

• Taxpayer = any person or organization that pays tax
(includes individuals and corporations)
Basic Terminology
4
• Incidence = ultimate economic burden of a tax

 May not fall on the person or organization who pays tax
 Corporation’s customers indirectly pay the tax in the form of
higher price for the same product
• Jurisdiction = right of a government to tax
 U.S. citizens
 Permanent residents
 Non U.S. citizens or residents but earn income from a
source within the U.S.
Application Problem
5
In each of the following cases, determine whether the United States has
jurisdiction to tax Mrs. CM.
a. Mrs. CM is a citizen of Brazil but is a permanent resident of Orlando,

Florida.
b. Mrs. CM is a citizen and resident of Brazil. She owns Manhattan real

estate that generates $ 100,000 net rental income annually
c. Mrs. CM is a citizen and resident of Brazil. She owns no property and

conducts no business in the United States.
d. Mrs. CM is a U.S. citizen but is a permanent resident of Sao Paulo,

Brazil.
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Tax Formula
6
Tax = rate × base

• Rate can be:
• Flat rate: single rate applies to entire tax base
• Sales tax
• Graduated rate: multiple rates apply to portions

(brackets) of tax base
Graduated Rate
7
 The city of Springvale levies a tax on the value of real

property located within its city limits. The tax equals 2
percent of the property’s assessed value up to $ 500,000 plus 4
percent of the value in excess of $ 500,000.
Compute the tax on real property valued at $ 725,000

Tax Formula
8
• Base is an item, occurrence, transaction, or activity

on which a tax is levied (expressed in monetary
terms)
 Should be designed in order that taxpayers cannot easily avoid
or conceal
• Revenue is total tax collected by the government

 Increased by increasing either rate or base
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Two Ways to Characterize Taxes

9
• Frequency with which tax occurs

• Transaction (event) based taxes, such as:
• Sales or excise tax
• Estate or gift tax
• Activity based tax, such as:
• Income tax
• Link to specific government expenditures
• Earmarked to finance designated projects, such as:
• Local real property taxes are earmarked to support public
school system
• Federal payroll and self-employment taxes are earmarked to
support Social Security and Medicare systems
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Local Taxes
10
 Property (ad valorem taxes)

• Real property tax
 Real property or realty: land and whatever is erected or
growing on the land and permanently affixed to it
 The market value base is determined by tax assessors
 Tax rate is determined annually
• Springfield’s city council decides that the city must raise $ 1.2 million
of real property tax revenues during its next fiscal year.
Because Springfield’s tax assessor determines that the total value of
real property located within the city limits is currently $ 23 million, the
council sets the nominal tax rate for the upcoming year at 5.22 percent
($ 1.2 million - $ 23 million). This rate can be adjusted each year,
depending on Springfield’s future revenue needs and the fluctuating
value of its real property tax base.
Local Taxes
11
• Real property tax

• Different tax rate for different classifications of property
• Commercial vs. residential realty
• Abatement: a tax exemption for a limited period of time

• Governments usually use tax abatements to attract businesses
into their jurisdictions
• Tax savings could be significant for businesses
Local Taxes
12
• Personal property tax

 The market value base is determined by taxpayers
• Household tangibles (vehicles)

• Business tangibles (inventory, furniture and fixtures,
machinery, and equipment)
• Intangibles (securities)
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State Taxes
13
 Sales tax
• Broad-based, apply to most consumer goods and service, but
typically excludes necessities (food, drugs)
• Seller is responsible for collecting and remitting the tax to the
sate government
 Use tax
• Tax on the ownership, possession, or consumption of tangible
goods within the state
• Applied for the owner who did not pay state sales tax when
purchasing
• Personal responsibility for use tax
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State Taxes
14
Ms. Goode is a resident of Idaho, which has a 7 percent

sales and use tax. While on vacation in Hawaii, Ms.
Goode purchased a diamond bracelet for $ 7,600 and
paid $ 304 (4 percent) Hawaiian sales tax. Because Ms.
Goode did not pay her own state’s sales tax on the
purchase, she owes $ 228 use tax to Idaho. The use tax
equals $ 532 (7 percent of $ 7,600) minus a $ 304
credit for the Hawaiian sales tax. If Ms. Goode had
vacationed in California and paid that state’s 8.25
percent sales tax on her jewelry purchase, she would
not owe any Idaho use tax.
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State Taxes
15
Mrs. DK, a resident of Pennsylvania, traveled to Delaware to

purchase an oil painting from a local artist. The cost of the
painting was $ 9,400. Pennsylvania has a 7% sales and use
tax, while Delaware has no sales and use tax.
a. How much Pennsylvania use tax does Mrs. DK owe on the
purchase she made in Delaware?
b. How much Pennsylvania use tax would Mrs. DK owe if she
purchased the painting from a gallery in New York City and
paid New York’s 8.75 percent tax on the transaction?
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State Taxes
16
• Excise tax
• Imposed on retail sale of specific goods or services
• Cigarettes and gasoline
• Hotel and motel accommodations
• Income tax
• Personal
• Corporate
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Federal Taxes
17
• Individual income tax

• Corporate income tax
• Employment taxes
• Social Security
• Medicare
• Unemployment taxes
• Excise taxes
• Transfer taxes
• Gift
• Estate
• Generation-skipping
1-18
Foreign Taxes
18
• Income taxes similar to U.S.

• Value added tax (VAT)
• VAT is similar to a sales tax on the incremental value
added by manufacturing
• VAT is self-enforcing because the taxpayer can claim a
credit for VAT paid to a supplier with proof of payment
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Jurisdictional Competition
19
• Increasing the tax rate or expanding the

definition of the tax base can cause taxpayers
to flee the tax jurisdiction
• Current trends in increasing the tax base

• Gambling/lotteries
• Sales tax expansion
Quick Questions
20
Every state with a sales tax imposes a complimentary

tax on the ownership, possession, or consumption
of tangible goods within the state. This tax is a(n)
A. excise tax.
B. income tax.
C. penalty tax.
D. use tax.
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Chapter 1

Types of Taxes and the

• Define tax, taxpayer, incidence, jurisdiction

• Tax = compulsory payment to support

• contrast with fine/penalty or user fee

• Incidence = ultimate economic burden of a tax

a. Mrs. CM is a citizen of Brazil but is a permanent resident of Orlando,

b. Mrs. CM is a citizen and resident of Brazil. She owns Manhattan real

c. Mrs. CM is a citizen and resident of Brazil. She owns no property and

d. Mrs. CM is a U.S. citizen but is a permanent resident of Sao Paulo,

Tax = rate × base

• Graduated rate: multiple rates apply to portions

 The city of Springvale levies a tax on the value of real

Compute the tax on real property valued at $ 725,000

• Base is an item, occurrence, transaction, or activity

• Revenue is total tax collected by the government

Two Ways to Characterize Taxes

• Frequency with which tax occurs

 Property (ad valorem taxes)

• Real property tax

• Abatement: a tax exemption for a limited period of time

• Personal property tax

• Household tangibles (vehicles)

Ms. Goode is a resident of Idaho, which has a 7 percent

Mrs. DK, a resident of Pennsylvania, traveled to Delaware to

• Individual income tax

• Income taxes similar to U.S.

• Increasing the tax rate or expanding the

• Current trends in increasing the tax base

Every state with a sales tax imposes a complimentary

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