In this lesson students learn why the government taxes, where the money goes, and how different income brackets pay different taxes. They also learn about their individual responsibility to pay taxes, and that their gross salary does not always reflect what they will actually take home. Finally, the class will examine ways to lower taxes through deductions, retirement accounts, etc.
Students will be able to:
- Analyze a pay stub
- Identify pre-tax and after-tax deductions
- Understand why people pay taxes
- Compare tax differences given 401(k) deductions
- Do a cost-benefit analysis of a 401(k) plan
- Critique public vs. private responsibility
(3) 45-minute class periods
Do It YourselfMPEG 4 Video
Tim Bouchard, a web designer and entrepreneur, discusses the responsibilities of managing his expenses and meeting his financial needs.
GPO Access: Budget of the United States Government : Historical Tables Fiscal Year 2005
This site has complete information on U.S. federal government expenditures for the fiscal year 2005.
Before The Lesson
Bookmark the Web site used in the lesson on each computer in your classroom. Using a social bookmarking tool such as del.icio.us or diigo (or an online bookmarking utility such as portaportal) will allow you to organize all the links in a central location.
Preview all of the video segments and Web sites used in the lesson to make certain that they are appropriate for your students, currently available, and accessible from your classroom.
Download the video segment used in this lesson onto your hard drive, or prepare to stream the segment from your classroom.
1. Begin a discussion with students about jobs, the kind they currently have or would be interested in having in the future. Discuss what kinds of jobs students would like when they grow up, and what kind of income they hope to earn.
- How many of you have a job, or are interested in finding one?
- What kind of job would you like now? When you grow up?
- How much money do you think you can earn in a week?
- Has anyone collected a paycheck before?
2. Continue the discussion with students who have collected a paycheck by discussing the fact that all of their earned income does not go directly to them.
3. Lead the students into a discussion of how much tax is taken out of a paycheck and the factors that impact net income. Ask students the following questions:
- Did you know that you won't be able to "take home" every dollar you earn?
- How much do you expect to pay in taxes?
- How many of you would like to learn how to save more money, and pay less in taxes at the same time?
Learning Activity 1: Paycheck
1. Begin by distributing the Pay Stub Example Organizer (PDF) to each student.
2. On the board or a transparency, define the following terms with the students:
- Gross pay: The total amount of salary paid before any deductions are taken out.
- Net pay: The amount of salary received after taxes and deductions have been taken out.
- Taxes: Payments made to the Government that are withheld from income.
- Deductions: Money taken out of a paycheck for retirement accounts and eligible medical and dental insurance plans. The deductions for those types of benefits are not taxed by the federal government, which means they are essentially excluded from federal taxable wages.
3. Have the students identify the above-defined terms to the corresponding numerical value on the paycheck organizer.
4. Ask students to provide an example of each type of deduction and benefit and then help them define what those terms mean:
- Federal Income Tax: Taxes taken out of a paycheck that go to the federal government.
- State Income Tax: Taxes taken out of a paycheck that go to the state government.
- City/Local Income Tax: Taxes taken out of a paycheck that go to the city/local government. Explain that not everyone pays city or local taxes; it depends on where you live and work.
- Social Security: Withholdings that go into the federal government program that provides income support to people who are unemployed, disabled, or over the age of 65.
- Medicare: Withholdings that go into the federal health insurance program for people 65 and older, and also for people with disabilities.
- Deductions: 401(k) - This is an investment account that is used for retirement. Income paid to this account is tax-deferred, which means that taxes generally are not paid until retirement. Sometimes the employer also makes contributions to this account, and they are also tax-deferred.
5. Discuss the value of the deductions and benefits. Explain that "before-tax deductions" are a good value because they reduce the tax burden of the employee. On the Pay Stub Example Organizer, categorize the deductions as “before-tax” or “after-tax.” The amounts with an asterisk next to them on the paycheck are before-tax deductions which mean they are excluded from federal taxable wages. These include: 401(k), dental insurance, HMO or medical insurance, and the dependent care spending account, which is money that can be set aside to pay for child care or care for the sick or elderly.
The deductions on the Pay Stub Example Organizer that are not excluded from federal taxable wages are life insurance, and the any 401(k) loan repayment.
Part II – The Impact of Taxes
1. Ask students to describe what the greatest impact taxes have on an individual’s take-home pay. (Answer: Taxes decrease take-home pay.) Next ask students how deductions can affect take-home pay? ( Answer: Deductions can lower the taxes you pay.)
2. Distribute the Where Does Your Money Go Organizer and ask students to compute the following on the first portion of the handout using the numbers from the Pay Stub Example Organizer:
- The percentage of gross earnings paid in taxes (total taxes/gross earnings. The equation is $81.91 / $452.43 = 18%).
- The percentage of the federal taxable gross paid in taxes (total taxes/federal taxable gross. The equation is $81.91 / $335.85 = 24%).
- The percentage of gross earnings that is the net pay (net pay/gross earnings. The equation is $259.38 / $452.43 = 57%).
3. Use the tax rate, or percentage of income paid in taxes, calculated from the total taxes/federal taxable gross equation to compute the amount of taxes that would have been paid if there were no deductions. This would be the tax rate, just defined, times gross earnings. Compare those two numbers using the second portion of the Where Does Your Money Go? Organizer. See answers below:
- Tax rate with deductions (total taxes/federal taxable gross. The equation is $81.91 / $335.85 = 24%).
- Taxes paid without deductions (total taxes/federal taxable gross) x gross earnings. The equation is 24% * $452.53 = $108.60).
- Compare the total taxes from the pay stub to the answer above. (The equation is $108.60 - $81.91 = $26.69).
4. Complete the lesson by gauging the students' opinion of the tax rate. Ask students if their first impression of the tax rate is fair or excessive.
Learning Activity 2: Comparing Deductions
Part I – Introduction to Savings
1. Continue discussion of the previous day with a talk about savings accounts.
2. Ask students who might have a savings account from jobs worked or gift money. Ask who might have a savings or investment account for college savings.
3. Ask students at what age they plan to retire. Ask what lifestyle they hope to live when they do retire.
Part II – Analyzing Different Deduction Options
1. Review the paycheck that was analyzed in the previous day's lesson.
2. Identify and define the different types of “before-tax” deductions listed on the paycheck. These are the deductions with the asterisk next to them that are excluded from federal taxable wages.
- 401(k): This is an investment that will go toward the employee's retirement. This investment is "tax-deferred" which means the employee will not pay taxes until the contributions and earnings are distributed (generally upon retirement). Not paying taxes means that your investment will increase in value much more quickly. An added benefit is that most people will pay less tax on income when they retire as they will be earning less money in which case they will probably be in a lower tax bracket. Deferring the tax payment until a person is retired means that they will likely pay less tax.
- Dental: Contribution to an eligible dental insurance account.
- HMO: Contribution to an eligible medical insurance account.
- Dep Care FSA: Contribution to the employee's spending account for child care or care for the sick or elderly. This is non-taxed income put aside in a "spending account" to use to pay for those expenses.
3. Discuss the concept of a retirement investment plan, like a 401(k). Explain to the class that many people would like to save money for retirement in addition to what the government provides via social security. There are different ways to do this, and employers can help out. Some investment plans are tax-advantaged (they are made from pre-tax earnings) while others are not. Some examples are provided below. Write the following terms on the board and define:
- 401(k): An employer-sponsored retirement savings plan funded with money deducted from pre-tax salary, up to an annual cap established by Congress. The employer may match some or all of the employee's contribution.
- Mutual fund: A professionally managed investment that pools the capital of thousands of investors to trade in different securities, like stocks and bonds, depending on the investment objectives of the fund. Because most mutual funds hold a large number of securities, they offer investors the opportunity to diversify, as well as the benefits of portfolio management.
- Compound interest: The interest earned on interest already earned from an investment. It can be figured annually, monthly, or daily.
4. Compare the following figures from the equations that the students computed on the Where Does Your Money Go Organizer .
- The net pay after the deductions. ($259.38)
- The net pay without the deductions (apply the tax rate to the gross earnings. The tax rate computed is 24%).
- The taxes paid given the pre-tax deductions. ($81.90)
- The taxes paid without the pre-tax deductions. (total taxes/federal taxable gross) x gross earnings. The equation is 24% * $452.53 = $108.58).5. Then compare the taxes paid in the two cases. Be sure that students understand that the lower the taxable income you make, the less taxes you pay. This means that deductions which lower income, save money in taxes paid. In this example the amount saved in taxes is $26.69.
5. Save the Where Does Your Money Go? Organizer for the next lesson.
Part III: The Impact of Saving Over Time
1. Ask students if they think saving over a period of time can affect their lives. Ask students to think about how different their lives can be if they decide to save or not to save, then discuss. Next tell students they are going to take a look at some numerical scenarios that show how saving over time can impact their personal savings as well as their tax payments. Ask students to take out the Where Does Your Money Go? Organizer and the Pay Stub Example Organizer.
2. Create a spreadsheet that you will hand out to the students (or, if you have access to computers, have the students create a spreadsheet) with different scenarios that calculate taxes paid over 30 years with and without deductions, and how much an investment account can grow over 30 years.
- Taxes paid over 30 years with deductions
- Taxes paid over 30 years without deductions
- 401(k) deductions growth with compound interest of 5% over 30 years
3. To create the spreadsheet do the following:
a. Column A, Rows 1-30: Multiply the "total taxes" number by 52 (since the payments are weekly) to get the full-year amount. Put that number in each of the 30 cells. Compute the total (the formula to put in cell A31 is "=sum (A1:A30)." Total taxes = $81.91 * 52 = $4,259.32. The sum of thirty years of taxes is $127,779.60.
b. Column B, Rows 1-30: Number from 2.b. on the Where Does Your Money Go? Organizer multiplied by 52 in each of the 30 cells. Compute the total (the formula to put in cell B31 is "=sum(B1:B30)." This would be 24% * $452.43 = $108.58. The full-year amount would be $108.58 * 52 = $5646.16. The sum of 30 years of these taxes would be $169,384.80.
c. Column C, Rows 1-30: Multiply the 401(k) deduction total by 52 to get the full-year amount ($1560). Put that total in the first cell (1C). Then copy the following formula through the following 29 cells in that column: =(1C*1.05)+1560. The final cell will have the culminated investment earnings from 30 years of 401(k) savings with a 5% return, or interest rate. (The final amount is $103,644,60).
4. Explain to the students that the above equation adds 5% to the previous cell's total, representing a 5% gain in interest in the 401(k) account. Then it adds that year's contribution to the previous year's contribution plus interest gain.
5. Discuss which scenario yields the most income.
Learning Activity 3: The Final Analysis
Part I : Making Deductions
Prior to the debate, it would be helpful to assist students in defining their ideas and opinions about public vs private responsibility as it pertains to social welfare, health care and unemployment benefits.
1. Resume the discussion about who in the class works, and what kind of jobs they have held.
2. Discuss if they have ever been laid off or have known anyone who has been laid off, and for how long, etc. Ask how someone covers their expenses during a lay-off? What happens to their health care, savings and benefits?
3. Tell students that while most individuals have taxes deducted automatically from their pay, others who are independent contractors or own businesses are responsible for making these deductions themselves. Tell students they are going to see a video about Tim, a business owner. While watching, ask students to pay attention to the kinds of taxes, insurance, and retirement benefits Tim has to pay as a business owner. Play Do It Yourself MPEG 4 Video.
4. After watching the video, take student responses. Ask the class what sorts of taxes, insurance, and retirement benefits Tim had to pay for himself when running his own business. (A: Tim has to pay for taxes, health insurance, and his retirement savings plan).
5. Next, open a discussion of public vs. individual responsibility in terms of income, benefits, retirement, etc. Ask students whether or not they think the government should pay for health care, education, and income for the unemployed, or if it's each citizen's personal responsibility to pay for those services.
Part II: The Government and Your Tax Dollars
1. Review the previous day's lesson, in particular the statistics of taxes vs. net pay vs. gross pay.
2. Open up a discussion by asking students where do they think their tax dollars go. How does the government use your tax dollars?
3. Hand out the chart analysis of the federal budget from:
(Table 3.1-Outlays by Superfunction and Functions)
(Table 3.2-Outlays by Functions and Subfunction)
4. Conduct a 10-minute discussion on the major areas of the budget. Ask students to identify the spending amounts that correspond to the following areas in the budget:
- National defense (How much is spent on defense? What percentage of the overall budget goes for this allocation?)
- Human resources (How much is spent on education, health, medicare, social security? What percentage of the overall budget goes for this allocation?)
- Physical resources (How much is spent on energy, transportation, infrastructure like bridges and tunnels, regional development? What percentage of the overall budget goes for this allocation?)
- Interest on debt (How much is spent on interest on public debt? What percentage of the overall budget goes for this allocation?)
5. Ask students to suggest what the government should pay for. Write each suggestion on the board.
6. With each new idea, ask for a show of hands of who agrees with what the government should pay. Be sure to explain to the class that if the government does not pay for these items in the budget, then individuals (taxpayers) would be responsible. What would the implications be if the government didn't pay for these things?
1. Remind the class of the previous day’s activity of determining what the federal government budget should include. Based on these ideas, have the class determine a new federal budget based on the items from the activity above that received the most show-of-hands support.
2. Divide the class into two teams. Have one team argue for the class federal budget developed at the beginning of class, while the other side argues for the current federal budget breakdown.
3.Each side has to include an analysis of public vs. private responsibility.
4. Hold a short discussion after the debate to determine who made the better argument.
Students can identify and write to their congressperson about concerns that have regarding 1) the tax rate; 2) the federal budget; and 3)how tax dollars are spent.
Investigate recent tax cuts signed into law and create a debate about recent changes to the tax code.