Proportional, Progressive, and Regressive taxes

Taxes can be categorized by the impact they have on the allocation of income and wealth. A proportional tax is a tax that imposes the same relative onus on every taxpayer—i.e., when tax liability and income move in the same scale. A progressive tax is characterizable by a more than proportional rise in the tax burden in relation to the rise in income, and a regressive tax is recognisable by a less than proportional growth in the relative liability. Hence, progressive taxes are regarded as fighting a lack of equality in income distribution, but regressive taxes can result in an increase 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 in the upper-income class—in particular if a taxpayer is allowed to lower his tax base by nominating deductions or by excluding some income elements from his taxable income. Proportional tax rates if applied to lower-income classes could also be more progressive if such personal exemptions are made.

Income measured over a given period may not necessarily provide the most accurate measure of taxpaying status. For example, transitory rises in income might be saved, and in temporary declines in income a taxpayer might decide to provide for consumption by decreasing savings. Thus, if taxation is compared along with “permanent income,” it will be less regressive (or more progressive) than when held in comparison with annual income.

Sales taxes and excises (excepting luxuries) are mostly regressive, because the portion of own income consumed or spent on a specific good lowers as the amount of personal income is raised. Poll taxes (also called head taxes), calculated as a standard amount per capita, patently are regressive.

It is not simple to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of uncertainty around the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden is dependant fundamentally on whether a national or a subnational (that is, provincial or state) tax is being decided.

In considering the economic purposes of taxation, it is necessary to differentiate between varied ideas of tax rates. The statutory rates are nominated in law; usually these are marginal rates, but for some cases they are median rates. Marginal income tax rates denote the fraction of incremental income that is demanded by taxation when income rises by one dollar. So, if tax burden grows by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax statutes generally contain graduated marginal rates—i.e., rates that increase as income rises. Careful analysis of marginal tax rates should review provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) decreases by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points greater than indicated within the statutory rates. Since marginal rates signify how after-tax income changes in response to changes in before-tax income, they are the important ones for considering incentive effects of taxation. It is even more difficult to understand the marginal effective tax rate applied to income from business and capital, because it may be reliant on such considerations as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem shows that the marginal effective tax rate in income from capital is zero under a consumption-based tax.

Average income tax rates show the portion of total income that is demanded in taxation. The pattern of average rates is the one that is necessary for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates commonly increase with income, both because personal allowances are allowed for the taxpayer and dependents and also due to that marginal tax rates are graduated; conversely, preferential treatment of income received mostly by high-income households might dwarf these effects, allowing regressivity, as signified by average tax rates that decline as income rises.

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