Theme 4: What Is Taxed and WhyLesson 3: Income Tax Facts

Income taxes are collected on a "pay-as-you-earn" basis. This system of withholding taxes from employees' paychecks benefits the taxpayer and the government. Without withholding many would find it difficult to save enough money to pay their taxes at the end of the year. Government services may be interrupted without continuous funding throughout the year. At year's end, the amount withheld should roughly equal one's tax liability.

Many believe that the U.S. tax structure should be based on the principles of vertical equity and horizontal equity. Vertical equity means that people in different income groups should pay different amounts or different percentages of their incomes as taxes. Horizontal equity means that people in the same income group should pay the same amount of taxes.

Even with the principles of vertical and horizontal equity, it is possible that two families or two businesses with identical incomes will pay different income taxes. Tax deductions, exemptions, and tax credits may lower tax liability. The government allows this special tax treatment to support or encourage behaviors, spending patterns, and lifestyles considered desirable.

A tax deduction is an expense that can be deducted before a person or a business determines taxable income. Home mortgages, charitable contributions, business expenses, the number of dependents, and costs for education and child care are some variables that can affect a taxpayer's total tax liability.