There are three primary categories of taxes:
- Taxes on income:
- Paid by individuals, corporations, and other legal entities on various types of income including wages, interest, dividends, and capital gains
- Wealth-based taxes:
- Paid on the value of assets held and on wealth transfers
- Taxes on consumption:
- Sales taxes: Paid by the consumer
- Value-added taxes: Paid at each intermediate production step according to the amount of value added at the step; ultimately borne by the consumer
In most tax jurisdictions, a tax rate structure applies to ordinary income (such as earnings from employment). Other tax rates may apply to special categories of income such as investment income (sometimes referred to as capital income for tax purposes). Investment income is often taxed differently based on the nature of the income: interest, dividends, or capital gains and losses.
Many countries have a progressive ordinary tax rate structure. In a progressive rate structure, the tax rate increases as income increases.
In addition to imposing progressive tax rates on ordinary income, many countries tax investment returns differently depending on whether they are in the form of interest, dividends, or capital gains. For example, interest and dividends might be taxed at a reduced rate or taxed at ordinary rates after they exceed some amount. Long-term capital gains are often taxed at a lower rate than short-term capital gains, with long-term definitions varying from one to five years or so. In most countries, capital gains taxes are paid only when capital gains are realized.
Seven Global Tax Regimes shows seven global tax regimes delineated by whether the ordinary income tax rate is progressive or flat and by the treatment of investment income (i.e., interest, dividends, and capital gains).
Classification of Income Tax Regimes
| Income Tax Regime | 1 – Common Progressive | 2 – Heavy Dividend Tax | 3 – Heavy Capital Gain Tax | 4 – Heavy Interest Tax | 5 – Light Capital Gain Tax | 6 – Flat and Light | 7 – Flat and Heavy |
|---|---|---|---|---|---|---|---|
| Ordinary Tax Rate Structure | Progressive | Progressive | Progressive | Progressive | Progressive | Flat | Flat |
| Interest Income | Some interest taxed at favorable rates or exempt | Some interest taxed at favorable rates or exempt | Some interest taxed at favorable rates or exempt | Taxed at ordinary rates | Taxed at ordinary rates | Some interest taxed at favorable rates or exempt | Some interest taxed at favorable rates or exempt |
| Dividends | Some dividends taxed at favorable rates or exempt | Taxed at ordinary rates | Some dividends taxed at favorable rates or exempt | Some dividends taxed at favorable rates or exempt | Taxed at ordinary rates | Some dividends taxed at favorable rates or exempt | Taxed at ordinary rates |
| Capital Gains | Some capital gains taxed favorably or exempt | Some capital gains taxed favorably or exempt | Taxed at ordinary rates | Some capital gains taxed favorably or exempt | Some capital gains taxed favorably or exempt | Some capital gains taxed favorably or exempt | Taxed at ordinary rates |
| Examples | Austria Brazil China Finland France Greece Italy Japan Latvia United Kingdom United States | Argentina Indonesia Israel Venezuela | Colombia | Canada Denmark Germany Luxembourg Pakistan | Australia Belgium India Kenya Mexico New Zealand Norway Spain Switzerland Turkey | Kazakhstan Russia Saudi Arabia (Zakat) | Ukraine |
- Common Progressive Regime: This regime has progressive tax rates for ordinary income, but favorable treatment in all three investment income categories: interest, dividends, and capital gains. This was the most common regime observed.
- Heavy Dividend Tax Regime: This regime has a progressive tax system for ordinary income and favorable treatment for some interest and capital gains but taxes dividends at ordinary rates.
- Heavy Capital Gain Tax Regime: This regime has a progressive tax system for ordinary income and favorable treatment for interest and dividends, but taxes capital gains at ordinary rates.
- Heavy Interest Tax Regime: This regime has a progressive tax system for ordinary income and favorable treatment for dividends and capital gains, but taxes interest income at ordinary rates.
- Light Capital Gain Tax Regime: This regime has a progressive tax system for ordinary income, interest, and dividends, but favorable treatment of capital gains. This was the second most commonly observed regime.
- Flat and Light Regime: This regime has a flat tax system and treats interest, dividends, and capital gains favorably.
- Flat and Heavy Regime: This regime has a flat tax system for ordinary income, dividends, and capital gains. It does not have favorable treatment for dividends and capital gains, but has favorable treatment for interest income.
In addition to the different tax regimes in which different types of income are taxed at possibly different rates, there are other important dimensions in tax planning for investments. Some countries permit the use of tax deferred retirement accounts. A tax deferred account
- defers taxation on investment returns within the account;
- may permit a deduction for contributions;
- may occasionally permit tax free distributions.
On the other hand, a few countries impose a wealth tax on accumulations on a periodic basis which reduces after-tax returns and accumulations similar to income taxes.