Income tax

Case study 1

Mr x is a resident in country A, and he has a wife and two children.
In year 1:

  • Salary – Taxable
  • Consulting fee made once – Non-taxable if made once.
  • Bank interest payment – usually not taxable?
  • Capital gain from selling market shares – Taxable usually.
  • Rent payments or inheritance – Taxable in AT, but typically not.
  • Lottery wins – in Russia, yes, but generally not taxable. Professional players must pay taxes.

Taxable income: typical sources

  • employment – most popular type of income
  • self-employment
  • business
  • agriculture – not a high piece in developed countries
  • investment income
  • use of intangibles (royalties)
  • Capital gains = sales – cost.

Do all sources of income suffer the same tax burden?

For investment income, we have a 27.5 percent tax.
For real estate, we have a 30% tax.

Income tax rates

  • there is no natural rate of tax.
  • It depends only on policy.
  • People usually mean income tax when saying about tax rates.
  • Income taxes take a considerable part with nothing in return. It creates anger.

Income taxpayers and nontaxpayers are voters. So the social needs have to be solved by taxes.

Ways to design rates

  • Flat rate – the easiest to count.
  • Progressive rate increases with higher income.

If you have >1m€ per year in Austria, you pay 55% of tax; >100k€ 50% of tax.

Political parties use the lowering of low-income taxpayers (30-40% of the population) even though they pay too low taxes.

How is income tax levied?

by tax assessment:

  • on annual bass
  • Taxpayer files a tax return
  • The tax office assesses the tax due

by withholding tax (tax levied by payor), e. g., for:

  • Employment income
  • Investment income
  • In some countries: capital gains
    Withholding taxes are outsourcing for tax regulators. Withholding tax makes
    The employer pays all the taxes instead of the employee.
    Tax administration then always gets money at a time without minor problems as in case if employee paid it.

Withholding taxes employers pay monthly.

Pros and cost of withholding taxes

  • WHT secures tax revenues
  • WHT is efficient for tax administrations (but creates risks for payors)
  • WHT usually works on a gross basis (no deductions from WHT base)

Case study: which expenses are tax-deductible?

Mr. X has made the following expenses in Y1:

  • €1000 for expert literature (for his job) – Tax-deductible, because the book can be helpful only with his job
  • €500 for the business suit – generally tax-deductible, but in some cases, the government can say that you bought these clothes for everyday use. Example with McDonald’s outfit – Tax-Deductible, because no one uses this outfit, not on work.
  • Travel cost to the work – Can be tax-deductible and can be not, depends on policies.
    bank charges €1000
  • Renovation of the apartment last year with €0 for rent – renovation is made once in 10-20 years, so this year was nothing made, so no taxes.
  • A donation to the Red Cross of €200 – Is not tax-deductible. It is not based on business will but the will of a person. Sometimes policies incentivize donations in specific organizations.

Is income tax based on a gross or net basis?

Tax, commonly based on net income:

  • as a consequence of the ability to pay principle
  • Expenses related to items of taxable income are generally tax-deductible

Tax, based on gross taxation

  • In scheduler systems for specific categories of income
  • Where WHTs are applied – then voluntary tax assessment could be possible.

Specific types of expenses might be declared non-deductible, e. g.,

  • if relating to private life
  • if relating to non-taxable income
  • criminal fines, penalties

Sometimes generally, non-deductible are specifically made deductible:

  • Various policy reasons for granting deductions
  • E.g., housing loan, interest, specific donations, etc.

Case study

Mr. X has family-related expenses in Y1:

  • Child support €500 –
  • School fees €5000

Overall, Mr. X covers the general cost of living for his entire family.

Income tax and family situation

Various design options to reflect family situations for income tax purposes.

Individual taxation – not reflected at all:

  • Instead, typically, tax credits (or other family subsidies) are granted.
  • Overall, family income irrelevant to progressive tax rates.

Family/household taxation – overall family income as a tax base:

-Divided by the number of family members (e. g., was in France)

  • Strong lowering effect on progressive tax rates.

Marriage split – Family taxation for married couples:

A limited form of family taxation

  • Equal treatment of unmarried couples/singles
  • All policy options have different effects