Proportional, Progressive, and Regressive taxes

Taxes can be differentiated by the impact they have on the placement of income and wealth. A proportional tax is a tax that puts the same relative onus on all the taxpayers—i.e., where tax liability and income grow in equal scale. A progressive tax is recognisable by a more than proportional rise in the tax burden relative to the rise in income, and a regressive tax is characterized by a less than proportional growth in the comparable liability. So, progressive taxes are regarded as removing the lack of equality in income distribution, while regressive taxes may cause an increase in these inequalities.

The taxes that are normally considered progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, may become less so within the upper-income class—particularly if a taxpayer is permitted to reduce his tax base by claiming deductions or by leaving out particular income elements from his taxable income. Proportional tax rates that are applied to lower-income classes can also be more progressive if such personal exemptions are claimed.

Income measured over a given year may not definitely give the most accurate measure of taxpaying status. For example, transitory growth in income may be saved, and during temporary declines in income a taxpayer could choose to pay for consumption by taking from savings. Therefore, if taxation is compared along with “permanent income,” it should be less regressive (or more progressive) than if made comparable with annual income.

Sales taxes and excises (save on luxuries) are generally regressive, because the share of own income consumed or spent for specific goods lowers as the rate of personal income rises. Poll taxes (also termed head taxes), levied as a fixed amount per capita, patently are regressive.

It is difficult to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of a lack of certainty around 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 considered.

In considering the economic effects of taxation, it is essential to distinguish between various concepts of tax rates. The statutory rates are dictated in the law; commonly these are marginal rates, but in some cases they are average rates. Marginal income tax rates indicate the fraction of incremental income that is taken by taxation when income increases by one dollar. So, if tax onus rises by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax regulations generally contain graduated marginal rates—i.e., rates that grow as income increases. Structured analysis of marginal tax rates are required to take into account provisions as well as the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) reduces by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points more than indicated in the statutory rates. Since marginal rates display how after-tax income moves in response to changes in before-tax income, they are the appropriate ones for considering incentive effects of taxation. It is even more complicated to realise the marginal effective tax rate applied to income from business and capital, as it may depend on factors 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 nil under a consumption-based tax.

Average income tax rates show the part of total income that is required in taxation. The pattern of average rates is the one that is relevant for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates generally rise with income, both because personal allowances are provided for the taxpayer and dependents and also due to that marginal tax rates are graduated; on the other hand, preferential treatment of income received fundamentally by high-income households may dampen these effects, allowing regressivity, as indicated by average tax rates that fall as income grows.

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