Proportional, Progressive, and Regressive taxes

Taxes can be distinguished by the impact they have on the distribution of income and wealth. A proportional tax is the kind that puts the same relative onus on all taxpayers—i.e., where tax liability and income increase in equal levels. A progressive tax is characterized by a more than proportional rise in the tax onus in relation to the rise in income, and a regressive tax is recognised by a less than proportional increase in the related burden. Hence, progressive taxes are seen as reducing a lack of equality in income distribution, whereas regressive taxes are seen to cause an increase in these inequalities.

The taxes that are usually believed to be progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, could become less so for the upper-income class—in particular if a taxpayer is permitted to reduce his tax base by declaring deductions or by excluding some particular income parts from his taxable income. Proportional tax rates that are applied to lower-income groups will also be more progressive if such personal exemptions are declared.

Income measured over a given period might not absolutely provide the most accurate measure of taxpaying requirements. For example, transitory rises in income may be saved, and during temporary declines in income a taxpayer might choose to pay for consumption by reducing savings. Thus, if taxation is compared alongside “permanent income,” it would be less regressive (or more progressive) than if it is compared with annual income.

Sales taxes and excises (excepting those on luxuries) tend to be regressive, because the dissemination of individual income consumed or spent for specific goods lowers as the level of personal income increases. Poll taxes (also called head taxes), calculated as a flat amount per capita, obviously are regressive.

It is difficult to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to the lack of certainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of deciding who bears the tax burden lays fundamentally on whether a national or a subnational (that is, provincial or state) tax is being considered.

In regarding the economic purposes of taxation, it is relevant to distinguish between varied points of tax rates. The statutory rates will be dictated in legislature; usually these are marginal rates, but occasionally they are average rates. Marginal income tax rates denote the fraction of incremental income that is demanded by taxation when income grows by one dollar. Thus, if tax burden grows by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax legislation commonly contain graduated marginal rates—i.e., rates that grow as income grows. Heavy analysis of marginal tax rates must take into account provisions apart from the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lessens by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points higher than indicated by 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 know the marginal effective tax rate applied to income from business and capital, as it may rely on such factors 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 nothing under a consumption-based tax.

Average income tax rates indicate the portion of total income that is taken 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 increases with income. Average income tax rates commonly increase with income, both because personal allowances are allowed for the taxpayer and dependents and due to that marginal tax rates are graduated; conversely, preferential treatment of income received fundamentally by high-income households can swamp these effects, allowing regressivity, as signified by average tax rates that decline as income rises.

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