Proportional, Progressive, and Regressive taxes

Taxes can be distinguished by the effect they have on the placement of income and wealth. A proportional tax is one that impinges the same relative onus on all taxpayers—i.e., when tax liability and income grow in relative scale. A progressive tax is characterizable by a higher than proportional increase in the tax liability in regard to the rise in income, and a regressive tax is characterized by a less than proportional growth in the comparative onus. Thus, progressive taxes are viewed as taking away a lack of equality in income distribution, but regressive taxes are seen to have the result of an increase in these inequalities.

The taxes that are generally thought to be progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, can become less so within the upper-income categories—especially if a taxpayer is allowed to reduce his tax base by nominating deductions or by leaving out some particular income parts from his taxable income. Proportional tax rates which are applied to lower-income groups could also be more progressive if exemptions of a personal nature are made.

Income measured over a given period may not definitely offer the most appropriate measure of taxpaying requirements. For example, transitory growth in income can be saved, and during temporary declines in income a taxpayer could elect to provide for consumption by decreasing savings. Ergo, if taxation is held in comparison alongside “permanent income,” it can be less regressive (or more progressive) than if it is compared with annual income.

Sales taxes and excises (with the exception of luxuries) tend to be regressive, because the spread of individual income consumed or spent for specific goods lessens as the level of personal income grows. Poll taxes (also known as head taxes), calculated as a set 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 due to the lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of deciding who bears the tax burden depends essentially on whether a national or a subnational (that is, provincial or state) tax is being considered.

In regarding the economic purposes of taxation, it is necessary to distinguish between differing points of tax rates. The statutory rates will be dictated in the legislation; often these are marginal rates, but in some cases they are average rates. Marginal income tax rates signify the fraction of incremental income that is demanded by taxation when income increases by one dollar. Ergo, if tax liability grows by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislature often contain graduated marginal rates—i.e., rates that increase as income rises. Heavy analysis of marginal tax rates should regard provisions apart from the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lowers by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points higher than indicated within the statutory rates. Since marginal rates specify how after-tax income changes in response to changes in before-tax income, they are the relevant ones for appraising incentive effects of taxation. It is even more complicated to understand the marginal effective tax rate to apply to income from business and capital, because it may be reliant on factors including the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem determines that the marginal effective tax rate in income from capital is nothing under a consumption-based tax.

Average income tax rates indicate the percentage of total income that is demanded in taxation. The pattern of average rates is the one that is relevant for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates usually increase with income, both because personal allowances are granted for the taxpayer and dependents and also because marginal tax rates are graduated; on the other hand, preferential treatment of income received predominantly by high-income households might dampen these effects, allowing regressivity, as shown by average tax rates that decrease as income rises.

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