Taxes are confusing enough for a lot of adults, so you can only imagine how bewildering this subject might be for kids and teens. However, it is something that everyone will need to know by the time they start working and start paying taxes. In this blog post, we'll look at topics such as what taxes are, how they are paid, and why we have taxes.
Related: Financial literacy for kids
What are taxes?
A tax definition for kids should start with the basics of what tax is. Simply put, tax is money paid to the government by individuals and businesses that is used to fund public services like healthcare, education, and transport. Taxes are also used to help those who are less well-off, such as by providing benefits and pensions.
Some of the most common types of tax are Income Tax, National Insurance, VAT, and Vehicle tax, which we'll look at later in the article.
Some taxes come out of your income, while some are paid when you buy items or pay for services. Depending on how old your child is, you might want to explain tax percentages. It's a common point of confusion that reaching higher tax bands can leave people with a lower income, so this is not an easy concept to explain to kids. Start with the basics and explain that while the government takes tax money away, it always pays to work hard and earn more money. It can be easier to teach your kids with various money apps. Plus, you can explain that different items they buy will have different levels of Value Added Tax (VAT) depending on what the item is.
When your kids understand the basics of taxes, you can also tell them about all the different taxes that people pay:
Different types of tax
It's worth telling your kids that there are different types of taxes they will have to pay. The main types of taxes that it's worth teaching your children about are:
Income tax: The amount is based on how much they earn. For example, in the UK, people who earn less than £12,500 a year don't have to pay any income tax. After that, the amount of tax to be paid goes up in bands, depending on how much you earn. So, people who earn between £12,500 and £50,000 a year will pay 20% income tax on those earnings, while those who earn more than £150,000 a year will pay 45% income tax.
National Insurance: This is a social security tax that is taken from earnings. For instance, in the UK, everyone who is employed and earning more than £166/week will pay National Insurance. Similar to income tax, the amount of national insurance people pay goes up in brackets, based on their income.
There are also other taxes that people pay, though these work slightly differently from Income Tax and National Insurance. These include:
VAT: Value Added Tax (VAT) is added to the price of items before you buy them. For example, in the UK, the standard VAT rate is 20%, which means that if something cost you £15, you would have likely paid £2.50 in VAT. However, there are some items that have a lower rate of VAT, such as children's clothes and books, which have a 5% VAT rate.
Vehicle Tax: In the UK, you have to pay vehicle tax if you want to use a car or motorcycle on the road. Tell your teen about this type of tax before they look at getting their own car. The amount of tax you pay depends on factors such as the type of vehicle, its CO2 emissions, and when it was registered.
Council Tax: Every household has to pay Council Tax and the amount is based on where you live. For example, in the UK, the amount of Council Tax you pay is based on the value of your home and where it's located. If your home is in Band A, then you will pay the least amount of Council Tax, while those in Band H will pay the most.
When kids use their pocket money - for instance the money they earned by completing chores - to pay for purchases, they are indirectly paying taxes. This is because the government also adds taxes (VAT) to certain goods and services, which are used to fund infrastructure like healthcare and education. Every time they use their pocket money to buy something, they can be helping to pay for important facilities and services provided to others.
When is tax paid?
Tax is paid on earnings, depending on whether you're an employee, self-employed, or a business.
- If you're an employee, your employer will deduct Income Tax and National Insurance from your salary before they pay you. This is called PAYE (Pay As You Earn).
- If you're self-employed, you will need to complete a Self-Assessment tax return every year. This is a form that you fill in detailing your income and expenses for the year. You will then need to pay any tax that is owed by the end of January each year.
- Businesses have to pay Corporation Tax on their profits. This is usually paid quarterly, but can also be paid annually.
- VAT is paid at the time of purchase of certain goods and services. If a business has sales above the VAT threshold, they will need to become VAT registered and pay the VAT directly to HMRC.
- Other forms of tax include: inheritance, property gains and capital gains tax.
Why do employees pay taxes?
Employees pay taxes because it is their legal obligation to do so. The money that they pay in taxes goes towards funding vital public services like healthcare and education. Although paying taxes may seem like a burden, it actually has important social impacts that benefit everyone in society. In fact, paying taxes is one of the most important things that we as citizens can do to support our country, as well as live in a fair and safe society.
What is a pay stub and what does it consist of?
A payslip, or pay stub, is a document that shows how much an employee has earned and how much tax has been deducted from their wages. These are the main elements of a payslip.
- Gross pay: This is the amount of money you have earned before any taxes or deductions have been made.
- Net pay: This is the amount of money you'll receive after taxes and deductions have been made from your wages.
- Taxes and deductions: These include Income Tax, National Insurance, student loan repayments, and other deductions such as pension contributions.
- Paid leave: This is the amount of annual leave, sick leave, or other types of leave that you have earned.
- Other information: This can include your employer's name and address, your National Insurance number, and your tax code.
A pay stub is a good way to keep track of your earnings and how much tax you are paying. It is also useful for budgeting, as it can help you to see how much money you have available to spend after taxes and deductions have been taken into account.
Related: Help teens understand their first payslip
Does everyone pay the same amount of taxes?
The income tax system in the UK is progressive, which means that those who earn more money pay taxes at a higher rate than those who earn less. The amount of tax you pay varies, following a system of income brackets and tax rates. With this system, the government collects more money from those who earn more, in order to fund public services and help those who are less well-off.
The amount of tax you pay also depends on your personal circumstances, like whether you are married or have children. You may also be eligible for tax relief, which can reduce the amount of tax you owe.
What is the purpose of income tax in the UK?
- Education: Income tax helps to fund schools, vocational institutes, and universities so that everyone has access to education.
- Transport: Income tax helps to fund roads, railways, and other forms of public transport.
- The environment: Income tax helps to fund environmental protection schemes such as planting trees and cleaning up rivers.
- Defence: Income tax helps to fund the armed forces, which protect the UK from external threats.
- Public order and safety: Income tax helps to fund the police and other agencies that keep the public safe.
Income tax is collected to pay for a wide range of services that we use in everyday life, such as hospitals and roads. They are also used for social support by paying for benefits, facilities, and housing for people in need, including the disabled.
What is the purpose of National Insurance in the UK?
The NHS (National Health Service) provides healthcare and is paid for by taxation in the United Kingdom. The money raised from National Insurance or NI goes towards providing free and affordable healthcare for everyone who lives in the UK, along with the State Pension. The purpose of NI taxes is to ensure that everyone has access to quality healthcare, certain benefits, and a pension in retirement.
The amount of NI tax you pay depends on your employment status and how much you earn. Employees pay 13.25% of their earnings between £823 and £4,189 a month. The self-employed pay a percentage of their income as National Insurance depending on their taxable profits.
What is the purpose of Corporation Tax in the UK?
Corporation Tax is a tax that is paid on the profits of businesses and organisations. The money raised from Corporation Tax makes a significant contribution to funding essential public services. Through Corporation Tax, HMRC collects a percentage of profits earned, depending on the size of the business. Large businesses can be taxed at a higher rate than small businesses. Corporation Tax is also used to fund research and development, which can create new jobs and help to grow the economy.
What is the tax year?
The tax year is a way of measuring how much someone has earned, and thus how much tax they need to pay. All your kids will need to know is that the tax year goes from the 6th of April to the 5th of April every year.
History of tax in the UK
The first recorded income tax was introduced in England by William Pitt the Younger in 1798 to fund the Napoleonic Wars. Income tax was reintroduced in 1842 by Sir Robert Peel and has been a feature of the British tax system ever since. Income tax rates have varied over time, depending on government spending priorities and economic conditions. The highest rate of income tax on earnings was 83% in 1944, but Margaret Thatcher lowered it to 60% in 1980 and then 40% in 1989.
As for other types of tax, the UK has a long history of levying taxes on goods and services. In order to cut back on unnecessary spending, a purchase tax was established in 1940. This entailed a 33.3% tax on any goods deemed as luxury. VAT eventually replaced the purchase tax in 1973.
Since then, there have been many other indirect taxes, including excise duty (on items like alcohol and tobacco), stamp duty (on documents such as property deeds), and council tax (paid to local authorities).
Tips on how to help explain taxes to kids
Here are some potential approaches that you could use to introduce the topic of taxes with your children.
- Use everyday examples: You could explain taxes by using examples from daily life, like how the government adds taxes to items at the grocery store.
- Use props or visual aids: You could use familiar items to help explain taxes, like a piggy bank with money in it to represent the government collecting taxes.
- Practice Paying Taxes: Introduce them to the concept of taxes by taking a small percentage out of their pocket money and set out what that money will go towards such as household items.
- Go through your payslip: Show your kids a monthly payslip and walk them through the different breakdowns.
- Be honest: It's important to be truthful with children when explaining taxes. Explain taxes, what taxes are, and their role in society, in a simple and straightforward way.
- Use age-appropriate language: It's vital to use language that your teen will understand. Avoid using technical jargon or terms that they won't be familiar with.
- Key services: Stress the importance of taxes in providing vital infrastructure we all use, like hospitals and schools.
- Taxes for all: Emphasise that everyone has to pay taxes, regardless of their income or social status. You could also expand on this by explaining how different tax rates apply to people with different incomes, and how personal circumstances can affect the amount of tax you pay.
Learning about taxes is an important part of financial education. If you're looking for more ways to improve your child's financial knowledge, our in-app Money Missions can help. These fun bite-sized lessons are targeted to your child's age and knowledge level. There are quizzes on jobs & earning, budgeting & plans, modern money, and more.
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