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Proportional, Progressive, and Regressive taxes

Taxes are distinguished by the impact they have on the placement of income and wealth. A proportional tax is a tax that puts the same relative burden on each taxpayer—i.e., where tax liability and income grow in the same proportion. A progressive tax is characterizable by a greater than proportional growth in the tax onus in relation to the growth in income, and a regressive tax is recognisable by a less than proportional increase in the relative onus. Therefore, progressive taxes are seen as removing the lack of equality in income distribution, but regressive taxes are seen to have the effect of increasing these inequalities.

The taxes that are normally considered progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, can become less so in the upper-income group—especially if a taxpayer is allowed to lower his tax base by declaring deductions or by taking some income parts from his taxable income. Proportional tax rates which are applied to lower-income groups could also be more progressive if personal exemptions are made.

Income measured over the course of a given period may not necessarily come up with the most appropriate measure of taxpaying requirements. For example, transitory growth in income could be saved, and during temporary declines in income a taxpayer might opt to provide for consumption by decreasing savings. Ergo, if taxation is compared along with “permanent income,” it should be less regressive (or more progressive) than when made comparable with annual income.

Sales taxes and excises (with the exception of those on luxuries) tend to be regressive, because the spread of one’s income consumed or spent on specific goods declines as the rate of personal income is raised. Poll taxes (aka head taxes), calculated as a fixed amount per capita, patently are regressive.

It is difficult to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of a lack of certainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden is dependant essentially on whether a national or a subnational (that is, provincial or state) tax is being decided.

In analysing the economic purpose of taxation, it is essential to distinguish between varied ideas of tax rates. The statutory rates are dictated in 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 rises by one dollar. Hence, if tax liability increases by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax legislation usually contain graduated marginal rates—i.e., rates that increase as income rises. Structured analysis of marginal tax rates must 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 growth in income, the marginal rate is 20 percentage points higher than specified by the statutory rates. Since marginal rates display how after-tax income moves in response to changes in before-tax income, they are the necessary ones for assessing incentive effects of taxation. It is even more complicated to realise the marginal effective tax rate applicable to income from business and capital, since it may be reliant on considerations such as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem holds that the marginal effective tax rate in income from capital is zero under a consumption-based tax.

Average income tax rates indicate the part of total income that is taken in taxation. The pattern of average rates is the one that is important for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates generally increase with income, both because personal allowances are provided for the taxpayer and dependents and also because marginal tax rates are graduated; on the other side of things, preferential treatment of income received predominantly by high-income households can dwarf these effects, allowing regressivity, as displayed by average tax rates that decrease as income grows.

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