In the 1920s and 1930s, the United States created an extremely progressive income and estate taxation system, which, when combined with heavy corporate taxation, led to a large and sustained reduction in income and wealth concentration. That event was reversed after the country's progressive tax system went by the wayside.
Definition of Progressive Tax
A progressive tax increases personal tax rates as the taxable income of taxpayers rises. Tax brackets are formed that relate directly to segmented, personal income streams. Each substantial increase in a person's income pushes that taxpayer to the next tax bracket.
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For instance, a person's income may initially fall into one tax rate bracket, but a substantial increase in income will move the person to the next subsequent tax rate. For example, a progressive tax schedule might include a base tax rate of "0" percent and the highest tax rate of 45 percent.
Read More: Advantages and Disadvantages of Progressive Tax
Progressive Tax Examples
The U.S. federal income tax system is a progressive one. It relies on graduated tax brackets, the rates of which ranged from 10 percent to 37 percent for 2021. For that year, a single person with $15,000 of taxable income was in the 12 percent tax bracket, but a taxpayer with a taxable income of $600,000 was in the 37 percent tax bracket.
Investment Income Tax
The investment income tax relates to a taxpayer's income-generating efforts. Your investments affect the income tax you pay in two circumstances: if you receive income from an investment and if you experience a gain or loss when you sell a financial asset.
For instance, an investor may receive income in the form of interest and/or dividends. This income is typically taxed at the investor's ordinary income tax rate. In contrast, qualified dividends may receive a different tax treatment in the form of a lower long-term capital gains tax rate.
Read More: What Are the Benefits of the Progressive Tax?
Tax on Interest Earned
A taxpayer earns interest, or passive income, on savings accounts and investments. This interest income, including interest on deposit accounts, such as checking and savings accounts, is typically taxed at the same tax rate as is the taxpayer's earned income.
Other forms of earned interest include the following:
- Interest on checking and savings deposit accounts
- Interest on the value of gifts a taxpayer receives for opening an account with a financial institution
- Dividends on deposit or share accounts in credit unions, cooperative banks and other banking associations
- Interest you receive on loans
- Interest you receive on certificates of deposit (CDs)
- Interest on U.S. obligations such as U.S. Treasury bonds
- Interest on insurance dividends
- Interest on an annuity contract
- Original issue discount (OID) amounts on long-term debt instruments
- Interest on income tax refunds
Rental Earnings Tax
The rental earnings tax is a progressive tax that targets rental property income. The taxpayer reports all rental income on her tax return and, typically, the related expenses can be deducted from the taxpayer's rental income.
The estate tax is levied on the assets of an estate, which a deceased person has bequeathed to her beneficiaries. Whether a beneficiary pays an estate tax and, if so, the dollar amount of the tax depends on the monetary value of the assets included in the estate. As of 2021, a beneficiary who inherits an estate of more than $12,060,000, will pay a tax rate of 40 percent.
A tax credit is awarded by the government to a taxpayer. Tax credits include an earned income tax credit, an elderly and disabled tax credit, a child tax credit and the retirement savings contributions credit. For tax reporting purposes, tax credits are deducted from the tax the taxpayer owes, rather than from her gross income.