Proportional, Progressive, and Regressive taxes
Taxes can be categorized by the effect they have on the allocation of income and wealth. A proportional tax is the kind of tax that applies the same relative burden on all taxpayers—i.e., in the case where tax liability and income increase in the same levels. A progressive tax is characterizable by a greater than proportional rise in the tax onus in relation to the increase in income, and a regressive tax is recognisable by a less than proportional increase in the comparative burden. Hence, progressive taxes are viewed as removing inequalities in income distribution, while regressive taxes are found to result in increasing these inequalities.
The taxes that are generally considered progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, could become less so within the upper-income group—especially if a taxpayer is permitted to reduce his tax base by nominating deductions or by removing some income components from his taxable income. Proportional tax rates if applied to lower-income categories will also be more progressive if such personal exemptions are made.
Income measured over the period of a year does not necessarily come up with the most accurate measure of taxpaying ability. For example, transitory growth in income can be saved, and during temporary declines in income a taxpayer could elect to pay for consumption by reducing savings. Ergo, if taxation is regarded along with “permanent income,” it will be less regressive (or more progressive) than if held in comparison with annual income.
Sales taxes and excises (with the exception of those on luxuries) are generally regressive, because the share of individual income consumed or spent for a specific good declines as the level of personal income rises. Poll taxes (also called head taxes), levied as a fixed amount per capita, clearly are regressive.
It is not easy to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of 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 lays essentially on whether a national or a subnational (that is, provincial or state) tax is being considered.
In considering the economic effects of taxation, it is relevant to differentiate between several ideas of tax rates. The statutory rates will include those nominated in legislature; often these are marginal rates, but in some cases they are mean rates. Marginal income tax rates signify the fraction of incremental income taken by taxation when income increases by one dollar. Thus, if tax liability grows by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax legislature commonly contain graduated marginal rates—i.e., rates that rise as income grows. Careful analysis of marginal tax rates must review provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) falls by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points greater than nominated by the statutory rates. Since marginal rates display 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 understand the marginal effective tax rate applied to income from business and capital, because it may rely on such considerations 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 portion of total income that is paid in taxation. The pattern of average rates is the one that is important for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates usually rise with income, both because personal allowances are granted for the taxpayer and dependents and also because marginal tax rates are graduated; conversely, preferential treatment of income received fundamentally by high-income households could dwarf these effects, allowing regressivity, as signified by average tax rates that decline as income rises.
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