Proportional, Progressive, and Regressive taxes
Taxes can be distinguished by the effect they have on the placement of income and wealth. A proportional tax is the kind of tax that puts the same relative requirement on each taxpayer—i.e., in the case where tax liability and income grow in equal scale. A progressive tax is characterizable by a larger than proportional increase in the tax burden in relation to the increase in income, and a regressive tax is characterizable by a less than proportional growth in the comparative liability. So, progressive taxes are viewed as fighting inequalities in income distribution, whereas regressive taxes might have the result of an increase in these inequalities.
The taxes that are usually thought to be progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, can become less so in the upper-income demographic—particularly if a taxpayer is able to lower his tax base by nominating deductions or by taking particular income elements from his taxable income. Proportional tax rates if applied to lower-income demographics will also be more progressive if such personal exemptions are claimed.
Income measured over a given period might not definitely give the most suitable measure of taxpaying status. For example, transitory increases in income may be saved, and in temporary declines in income a taxpayer could select to pay for consumption by decreasing savings. Therefore, if taxation is regarded along with “permanent income,” it can be less regressive (or more progressive) than when held in comparison with annual income.
Sales taxes and excises (except those on luxuries) tend to be regressive, because the portion of one’s income consumed or spent for a specific good lowers as the level of personal income grows. Poll taxes (also called head taxes), levied as a flat amount per capita, clearly are regressive.
It is not simple to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to the lack of certainty around 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 considering the economic purposes of taxation, it is essential to distinguish between varied points of tax rates. The statutory rates are dictated in the legislation; generally these are marginal rates, but sometimes they are average rates. Marginal income tax rates signify the fraction of incremental income that is taken by taxation when income rises by one dollar. Ergo, if tax burden rises by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax statutes often contain graduated marginal rates—i.e., rates that rise as income rises. Careful analysis of marginal tax rates are required to regard provisions as well as the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) falls by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points greater than specified by the statutory rates. Since marginal rates signify how after-tax income is changed in response to changes in before-tax income, they are the appropriate ones for considering incentive effects of taxation. It is even more difficult to understand the marginal effective tax rate to apply to income from business and capital, since it may be reliant 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 zero under a consumption-based tax.
Average income tax rates display the part of total income that is required in taxation. The pattern of average rates is the one that is necessary 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 grow with income, both because personal allowances are provided for the taxpayer and dependents and because marginal tax rates are graduated; on the other side of things, preferential treatment of income received for the most part by high-income households could dampen these effects, allowing regressivity, as indicated by average tax rates that lessen as income increases.
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