Proportional, Progressive, and Regressive taxes

Taxes are differentiated by the impact they have on the allocation of income and wealth. A proportional tax is one that imposes the same relative burden on every taxpayer—i.e., in the case where tax liability and income increase in equal levels. A progressive tax is recognisable by a higher than proportional growth in the tax liability in relation to the increase in income, and a regressive tax is recognisable by a less than proportional increase in the comparable burden. Ergo, progressive taxes are seen as reducing inequity in income distribution, while regressive taxes may result in increasing these inequalities.

The taxes that are usually considered progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, might become less so within the upper-income demographic—especially if a taxpayer is able to lessen his tax base by nominating deductions or by taking some particular income parts from his taxable income. Proportional tax rates which are applied to lower-income classes will also be more progressive if personal exemptions are claimed.

Income measured over a given year might not definitely offer the most suitable measure of taxpaying requirement. For example, transitory increases in income could be saved, and in temporary declines in income a taxpayer may elect to finance consumption by taking from savings. Ergo, if taxation is made comparable with “permanent income,” it will be less regressive (or more progressive) than if it is compared with annual income.

Sales taxes and excises (except those on luxuries) are mostly regressive, because the share of individual income consumed or spent for a specific good lessens as the level of personal income increases. Poll taxes (also known as head taxes), calculated as a fixed amount per capita, clearly are regressive.

It is not simple to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of the lack of certainty about the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden rests crucially on whether a national or a subnational (that is, provincial or state) tax is being decided.

In considering the economic purpose of taxation, it is relevant to distinguish between differing ideas of tax rates. The statutory rates are those dictated in law; usually these are marginal rates, but occasionally they are average rates. Marginal income tax rates signify the fraction of incremental income that is taken by taxation when income grows by one dollar. Ergo, if tax liability increases by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax laws generally contain graduated marginal rates—i.e., rates that rise as income rises. Structured analysis of marginal tax rates should review provisions apart from the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) falls by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points greater than specified in the statutory rates. Since marginal rates indicate how after-tax income is changed in response to changes in before-tax income, they are the appropriate ones for appraising incentive effects of taxation. It is even more difficult to understand the marginal effective tax rate to apply to income from business and capital, since it may rely on considerations such as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem grants that the marginal effective tax rate in income from capital is zero under a consumption-based tax.

Average income tax rates determine the percentage of total income that is paid in taxation. The pattern of average rates is the one that is relevant for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates commonly rise with income, both because personal allowances are allowed for the taxpayer and dependents and also due to that marginal tax rates are graduated; on the flip side, preferential treatment of income received fundamentally by high-income households may dwarf these effects, producing regressivity, as shown by average tax rates that lower as income increases.

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