Proportional, Progressive, and Regressive taxes

Taxes can be distinguished by the impact they have on the distribution of income and wealth. A proportional tax is one that puts the same relative onus on all the taxpayers—i.e., in the case where tax liability and income move in equal proportion. A progressive tax is recognised by a more than proportional increase in the tax onus relative to the increase in income, and a regressive tax is characterized by a less than proportional increase in the relative onus. So, progressive taxes are seen as taking away inequity in income distribution, but regressive taxes are believed to have the result of an increase in these inequalities.

The taxes that are usually considered progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, may become less so for the upper-income categories—particularly if a taxpayer is permitted to lower his tax base by nominating deductions or by leaving out certain income elements from his taxable income. Proportional tax rates which are applied to lower-income demographics would also be more progressive if personal exemptions are made.

Income measured over a given year does not absolutely offer the most accurate measure of taxpaying requirements. For example, transitory rises in income can be saved, and within temporary declines in income a taxpayer could decide to pay for consumption by decreasing savings. Therefore, if taxation is held in comparison along with “permanent income,” it would be less regressive (or more progressive) than when compared with annual income.

Sales taxes and excises (with the exception of those on luxuries) are mostly regressive, because the spread of personal income consumed or spent for a specific good lowers as the amount of personal income rises. Poll taxes (also known as head taxes), nominated as a fixed amount per capita, clearly are regressive.

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

In assessing the economic effects of taxation, it is necessary to differentiate between varied ideas of tax rates. The statutory rates include those nominated in the legislation; often these are marginal rates, but for some cases they are median rates. Marginal income tax rates signify the fraction of incremental income that is demanded by taxation when income is increased by one dollar. Ergo, if tax liability increases by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax legislature usually contain graduated marginal rates—i.e., rates that rise as income grows. Careful analysis of marginal tax rates should review 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 higher than specified within the statutory rates. Since marginal rates specify how after-tax income increases or decreases in response to changes in before-tax income, they are the necessary 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, as it may be dependant on factors including 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 display the part of total income that is demanded in taxation. The pattern of average rates is the one that is in consideration for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates generally increase with income, both because personal allowances are provided for the taxpayer and dependents and because marginal tax rates are graduated; on the other hand, preferential treatment of income received predominantly by high-income households could swamp these effects, producing regressivity, as signified by average tax rates that decrease as income rises.

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