Proportional, Progressive, and Regressive taxes
Taxes are categorized by the effect they have on the allocation of income and wealth. A proportional tax is a tax that puts the same relative liability on all taxpayers—i.e., in the case where tax liability and income grow in the same proportion. A progressive tax is recognisable by a larger than proportional growth in the tax onus relative to the rise in income, and a regressive tax is characterizable by a less than proportional rise in the relative liability. Therefore, progressive taxes are thought of as removing a lack of equality in income distribution, while regressive taxes might result in increasing these inequalities.
The taxes that are often believed to be progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, can become less so in the upper-income class—in particular if a taxpayer is allowed to reduce his tax base by declaring deductions or by taking certain income parts from his taxable income. Proportional tax rates which are applied to lower-income categories can also be more progressive if personal exemptions are claimed.
Income measured over a given period does not necessarily give the most suitable measure of taxpaying status. For example, transitory rises in income could be saved, and in temporary declines in income a taxpayer may elect to provide for consumption by reducing savings. Therefore, if taxation is compared with “permanent income,” it should be less regressive (or more progressive) than if it is held in comparison with annual income.
Sales taxes and excises (save those on luxuries) are mostly regressive, because the portion of individual income consumed or spent on specific goods decreases as the amount of personal income is raised. Poll taxes (also known as head taxes), levied as a set amount per capita, clearly are regressive.
It is complicated to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of uncertainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden depends for the most part on whether a national or a subnational (that is, provincial or state) tax is being determined.
In analysing the economic effect of taxation, it is essential to differentiate between varied points of tax rates. The statutory rates are nominated in the legislation; commonly these are marginal rates, but sometimes they are mean rates. Marginal income tax rates note the fraction of incremental income that is taken by taxation when income grows by one dollar. So, if tax liability increases by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax statutes generally contain graduated marginal rates—i.e., rates that increase as income grows. Structured analysis of marginal tax rates are required to regard 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 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 increases or decreases in response to changes in before-tax income, they are the important ones for considering incentive effects of taxation. It is even more complicated to realise the marginal effective tax rate applicable to income from business and capital, as it may depend 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 nothing under a consumption-based tax.
Average income tax rates indicate the percentage of total income that is required 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 grows with income. Average income tax rates generally increase with income, both because personal allowances are allowed for the taxpayer and dependents and because marginal tax rates are graduated; on the other hand, preferential treatment of income received mostly by high-income households can dampen these effects, allowing regressivity, as shown by average tax rates that decrease as income grows.
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