Proportional, Progressive, and Regressive taxes

Taxes can be categorized by the effect they have on the distribution of income and wealth. A proportional tax is a kind that imposes the same relative requirement on every taxpayer—i.e., where tax liability and income increase in equal scale. A progressive tax is characterized by a greater than proportional increase in the tax burden in regard to the increase in income, and a regressive tax is recognisable by a less than proportional rise in the related onus. Therefore, progressive taxes are seen as removing inequalities in income distribution, while regressive taxes may have the result of an increase in these inequalities.

The taxes that are often considered progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, may become less so within the upper-income class—particularly if a taxpayer is permitted to reduce his tax base by claiming deductions or by excluding some particular income parts from his taxable income. Proportional tax rates if applied to lower-income groups will also be more progressive if such exemptions of a personal nature are made.

Income measured over the period of a year does not necessarily offer the best measure of taxpaying requirements. For example, transitory growth in income could be saved, and during temporary declines in income a taxpayer may opt to pay for consumption by decreasing savings. Ergo, if taxation is regarded with “permanent income,” it will be less regressive (or more progressive) than if it is compared with annual income.

Sales taxes and excises (except luxuries) are generally regressive, because the dissemination of personal income consumed or spent for specific goods lowers as the amount of personal income grows. Poll taxes (also termed head taxes), calculated as a fixed amount per capita, obviously are regressive.

It is complicated to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to the uncertainty about the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating 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 purpose of taxation, it is necessary to differentiate between differing concepts of tax rates. The statutory rates will include those specified in law; commonly these are marginal rates, but sometimes they are median rates. Marginal income tax rates signify the fraction of incremental income taken by taxation when income grows by one dollar. Thus, if tax liability rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislation usually contain graduated marginal rates—i.e., rates that rise as income increases. Structured analysis of marginal tax rates need to consider provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) decreases by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points more than indicated within the statutory rates. Since marginal rates display how after-tax income changes in response to changes in before-tax income, they are the important ones for assessing incentive effects of taxation. It is even more difficult to nominate the marginal effective tax rate applicable to income from business and capital, since it may be dependant on factors such as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem shows 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 relevant for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates commonly increase with income, both because personal allowances are granted for the taxpayer and dependents and because marginal tax rates are graduated; on the other hand, preferential treatment of income received for the most part by high-income households can swamp these effects, forcing regressivity, as displayed by average tax rates that lower as income rises.

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