Proportional, Progressive, and Regressive taxes

Taxes are categorized by the effect they have on the distribution of income and wealth. A proportional tax is the kind that imposes the same relative burden on every taxpayer—i.e., where tax liability and income move in equal levels. A progressive tax is recognisable by a larger than proportional growth in the tax burden in regard to the increase in income, and a regressive tax is recognisable by a less than proportional increase in the comparative liability. Therefore, progressive taxes are thought of as removing the lack of equality in income distribution, whereas regressive taxes are seen to have the result of an increase in these inequalities.

The taxes that are often believed to be progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, could become less so for the upper-income group—particularly if a taxpayer is permitted to reduce his tax base by nominating deductions or by leaving out some particular income components from his taxable income. Proportional tax rates that are applied to lower-income classes could also be more progressive if such personal exemptions are made.

Income measured over a given period does not absolutely give the best measure of taxpaying ability. For example, transitory growth in income can be saved, and during temporary declines in income a taxpayer might elect to finance consumption by reducing savings. Ergo, if taxation is regarded alongside “permanent income,” it will be less regressive (or more progressive) than if it is held in comparison with annual income.

Sales taxes and excises (save on luxuries) are usually regressive, because the portion of one’s income consumed or spent for a specific good declines as the level of personal income rises. Poll taxes (also known as head taxes), calculated as a flat amount per capita, patently are regressive.

It is not easy to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, 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 depends fundamentally on whether a national or a subnational (that is, provincial or state) tax is being debated.

In assessing the economic purpose of taxation, it is relevant to distinguish between varied ideas of tax rates. The statutory rates are those nominated in legislature; commonly these are marginal rates, but in some cases they are average rates. Marginal income tax rates denote the fraction of incremental income that is demanded by taxation when income is increased by one dollar. Ergo, if tax burden grows by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax statutes generally contain graduated marginal rates—i.e., rates that rise as income rises. Heavy analysis of marginal tax rates must take into account provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) decreases by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points more than specified within the statutory rates. Since marginal rates specify how after-tax income moves in response to changes in before-tax income, they are the relevant ones for regarding incentive effects of taxation. It is even more difficult to realise the marginal effective tax rate applicable to income from business and capital, because 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 nil under a consumption-based tax.

Average income tax rates indicate the fraction 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 generally rise 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 can dampen these effects, producing regressivity, as shown by average tax rates that decline as income grows.

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