The tax rate is set by national, state or municipal governments, and a separate rate may apply to each tax imposed. One consideration that affects tax rates is income, because individual and corporate income taxes are often set at progressive rates that seek a higher percentage of taxes from people who have higher income. Another factor affecting the tax rate is the dual aim of collecting as much tax as possible without discouraging or distorting economic activity. The product being taxed can determine how much it is taxed, because some areas tax so-called luxury items more than they tax basic necessities. A product's country of origin also may affect how much tax is paid on its purchase, because excise duties and import duties may be charged during shipping — and added to the final purchase price, which is then used to determine sales tax collected at the point of purchase.
Taxpayers are normally allowed to have a set amount of income that is tax-free each year, while taxable income above that level is subject to one or more tax rates, depending on how progressive the tax system is designed to be. People who are considered wealthy may pay a higher percentage of their income in taxes than someone who barely makes enough to keep food on the table. At the same time, wealthier taxpayers may be able to lower their tax rate more effectively than lower-income taxpayers, because they can afford to put some of their taxable income into accounts that either aren't taxed or are taxed at a lower rate.
While governments often have a goal of collecting as much taxes as possible, because more taxes generally means more money available to operate the government, they also have to balance that desire and set rates of taxation that encourage people to earn taxable income. Rates of income tax that are too high may discourage people from economic activity, because they won't see the point in working to make money if they keep so little of it after taxes. At the same time, an income tax system that contains reliefs and deductions for certain expenditures, such as pension contributions, can give taxpayers an incentive to work harder.
Indirect taxes on consumption often are applied at lower rates than income taxes but are effective at raising revenue because they apply to broad categories of expenditures at a percentage of the sales price. These taxes are favored by economists, because they do not distort economic activity, though this is only the case if they have a broad base and there are no exemptions or multiple tax rates. Taxes that are charged at each stage of production also have a cascading effect, so the consumer pays sales tax at a higher amount than the formal tax rate, often without realizing it. This is the case, because tax paid at the wholesale stage often is hidden in the retail price, on which further sales tax is charged.