Definition and Example of a Tax Base
A tax base is subject to taxation by a tax authority, such as a state or federal government, and is based on the total amount of:
- Other economic activity
There are two overarching types of tax bases: narrow and broad. A narrow tax base is seen as non-neutral and inefficient because less is taxed. On the other hand, a broad tax base is viewed more favorably as it taxes more, which reduces tax administration costs and allows for more revenue to be raised at lower tax rates.
Federal, State, and Corporate Tax Bases
Let’s look at three different examples of how tax bases work at the federal, state, and corporate levels.
Federal Income Tax
When it comes to federal income taxes, the tax base is the amount of income that gets taxed. The tax rate is a fraction of that base and is collected by taxation. Therefore, to calculate the total tax liability, you’ll multiply the tax rate by the tax base.
If a tax authority wants to achieve the same revenue target in different ways, it can either tax a narrower tax base at a higher rate, or a broader tax base at a lower rate. However, a broad tax base will always raise more revenue.
The federal income tax base is made up of all types of income, including:
- Capital gains
State Sales Tax
On a state level, sales tax is a strong example of how a narrow tax base comes to be. Many states have a narrow tax base because sales tax only applies to goods and not services. There may also be exemptions for necessities such as food, shelter, and medicine. Services remain largely exempt from state sales taxes; because of this, state tax bases tend to be narrow with higher sales tax rates. To make up for this, states would need to expand their sales tax base to include more services. This would allow them to have a broader tax base with a lower sales tax rate.
Corporate Income Tax
Because business income is considered to be federal taxable income, business income contributes to a corporate income tax base. The income that qualifies for the corporate income tax base is made up of the total of the business income of each member of the corporation, with the income and expenses related to intercompany transactions subtracted from that total.
Many businesses in the U.S. are pass-through entities, which means they are not subject to the corporate income tax like C corporations.
How a Tax Base Works
It all depends on what type of tax base you’re dealing with. On an overarching level, there are two types of tax bases: narrow and broad.
Broad vs. Narrow Tax Bases
Broad tax bases reduce tax administration costs and make it possible to raise more revenue at lower tax rates. Narrow tax bases, which are caused by a variety of deductions and exemptions, are viewed as non-neutral and inefficient as they do not raise much revenue.
A tax base may be narrow, rather than broad, due to:
- Tax expenditures that result in reduced tax revenue, such as credits, exemptions, and deductions
- Deductions that reduce taxable income when certain conditions are met
- Exemptions that keep things from being subject to taxation due to category, class, or status
- Tax expenditures such as the standard deduction against taxable income, child tax credits, and certain sales tax exemptions
- Services, since taxing services is administratively challenging
- The exemption of tangible and intangible personal property from the property tax base
- Exceptions that help avoid tax pyramiding, which can lead to high effective tax rates for certain industries
- A tax base is the total amount of property, consumption, assets, transactions, income, or other sort of economic activity that is subject to taxation by an authority, such as the government.
- A narrow tax base is considered to be non-neutral and inefficient, and can be caused by a variety of deductions and exemptions. This means it doesn’t ultimately tax that much.
- A broad tax base is viewed more favorably as it reduces tax administration costs and allows for more revenue to be raised at lower tax rates.