What Are Taxes & Why Do We Have To Pay Them? | Capital One (2024)

Taxes are a part of life for many people. When tax season comes around, taxpayers are often used to organizing their information, filing tax returns and waiting for any tax refunds.

But not everyone may understand what taxes are—or why individuals and businesses have to pay them. This guide breaks down how taxes work and what the most common tax types are to help you be informed during tax season.

Key takeaways

• Taxes are mandatory payments made by people and businesses that help fund government services at the federal, state and local level.
• Tax revenue pays for things like Social Security and Medicare, education, national defense, infrastructure and other goods and services intended to benefit the community.
• Federal, state and local governments may levy three main types of taxes: income-based taxes, wealth-based taxes and consumption-based taxes.

According to the IRS, taxes are “required payments of money to governments that are used to provide public goods and services for the benefit of the community as a whole.” Most people and corporations are required to pay taxes in the United States.

Taxes may be imposed by federal, state and local governments. The IRS—or Internal Revenue Service—is a government agency that enforces tax laws and collects federal taxes.

Taxes are the main source of income for the U.S. government. Revenue from taxes is used to fund goods and services for the public—like roads, schools and a variety of programs.

Take a closer look at some of the ways federal, state and local taxes are used in the U.S.

Federal tax revenue—plus revenue from court fines, licensing fees and payments to government agencies—may be used to pay for national services and programs, including:

• Social Security
• Health care like Medicare and Medicaid
• National defense
• Economic security programs
• Transportation and emergency services
• Veterans benefits
• Public infrastructure like bridges and roads

State and local governments may tax things like income, sales, fuel and property. State and local taxes may pay for services that include:

• Public schools and higher education
• Health care like Medicaid and the Children’s Health Insurance Program (CHIP)
• Public transportation and infrastructure
• Family financial assistance like the Temporary Assistance for Needy Families program
• Corrections programs

States may also receive grants from the federal government to help pay for things like health care, social services and infrastructure.

The U.S. government levies three main types of taxes on what you earn, own and buy. Learn what’s included in each type of tax.

Income taxes are based on an individual or organization’s earned and unearned income. Earned taxable income typically comes from salaries, wages, commissions and tips. And unearned income may come in the form of interest and stock dividends.

The federal government and most state governments collect corporate and individual income taxes. Some local governments levy income taxes too. But some states don’t collect income taxes at all. In these states, other types of taxes might be higher to make up for the lack of income tax revenue.

Income taxes can be broken down into different categories based on the source of the income:

• Personal income taxes: Taxes based on an individual’s income. The federal government uses a progressive tax system that applies higher tax rates to people who make more money. But a number of factors—like filing status, source of income, pre-tax contributions and eligible tax deductions and credits—could affect how much a taxpayer owes.
• Capital gains taxes: Taxes based on the profit from selling certain assets like a house, jewelry or art, and some investments like stocks and bonds. Capital gains taxes can levy a short-term or long-term rate, depending on how long the taxpayer owned the asset.
• Payroll taxes: Taxes typically withheld from a paycheck by an employer. This may include Social Security, Medicare and federal income taxes.
• Corporate income taxes: Taxes assessed on a corporation’s earned or unearned income.

Wealth-based taxes are typically applied to the things people or businesses own, including:

• Property taxes: Property taxes are usually imposed on real estate. But some types of tangible personal property like boats, cars and business equipment are subject to taxes too—referred to as Tangible Personal Property taxes.
• Estate taxes: Estate taxes are a tax on the right to transfer property at the time of someone’s death. Estate taxes are applied to the deceased person’s gross estate—or the total amount of assets they transferred to an heir, like money and property.
• Inheritance taxes: Inheritance taxes are similar to but less common than estate taxes. Instead of being imposed on the estate of the deceased person, inheritance taxes are paid by their heirs.

Consumption-based taxes are typically imposed on things people or businesses buy, such as:

• Sales taxes: Sales tax is applied to nearly every retail purchase. It’s typically a set percentage of the total cost that’s determined at the state and local level.
• Excise taxes: Excise taxes are imposed on certain goods or services like fuel, airline tickets, tobacco, indoor tanning and gambling.