Proportional, Progressive, and Regressive taxes
Taxes are differentiated by the effect they have on the distribution of income and wealth. A proportional tax is the kind of tax that impinges the same relative requirement on every taxpayer—i.e., where tax liability and income move in the same proportion. A progressive tax is recognisable by a more than proportional rise in the tax liability relative to the increase in income, and a regressive tax is recognisable by a less than proportional increase in the comparative burden. Therefore, progressive taxes are regarded as reducing a lack of equality in income distribution, but regressive taxes can result in increasing these inequalities.
The taxes that are often considered progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, might become less so within the upper-income group—particularly if a taxpayer is permitted to reduce his tax base by declaring deductions or by excluding some particular income components from his taxable income. Proportional tax rates which are applied to lower-income categories could also be more progressive if personal exemptions are declared.
Income measured over the course of a given year does not absolutely provide the most appropriate measure of taxpaying requirements. For example, transitory growth in income can be saved, and within temporary declines in income a taxpayer could choose to finance consumption by reducing savings. So, if taxation is made comparable along with “permanent income,” it would be less regressive (or more progressive) than if held in comparison with annual income.
Sales taxes and excises (save on luxuries) tend to be regressive, because the share of own income consumed or spent on a specific good lowers as the rate of personal income rises. Poll taxes (aka head taxes), calculated as a set amount per capita, obviously are regressive.
It is hard to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to the lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden is dependant for the most part on whether a national or a subnational (that is, provincial or state) tax is being debated.
In analysing the economic purposes of taxation, it is necessary to differentiate between several ideas of tax rates. The statutory rates include those nominated in legislation; generally these are marginal rates, but occasionally they are median rates. Marginal income tax rates denote the fraction of incremental income that is demanded by taxation when income rises by one dollar. So, if tax burden grows by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax regulations generally contain graduated marginal rates—i.e., rates that grow as income increases. Heavy analysis of marginal tax rates must regard provisions as well as the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) reduces by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points higher than specified in the statutory rates. Since marginal rates indicate how after-tax income increases or decreases in response to changes in before-tax income, they are the necessary ones for assessing incentive effects of taxation. It is even more difficult to understand the marginal effective tax rate to apply to income from business and capital, because 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 determines that the marginal effective tax rate in income from capital is nil under a consumption-based tax.
Average income tax rates display the fraction of total income that is paid in taxation. The pattern of average rates is the one that is in consideration for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates commonly increase with income, both because personal allowances are permitted for the taxpayer and dependents and because marginal tax rates are graduated; conversely, preferential treatment of income received for the most part by high-income households might swamp these effects, forcing regressivity, as indicated by average tax rates that fall as income grows.
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