Proportional, Progressive, and Regressive taxes
Taxes can be differentiated by the effect they have on the distribution of income and wealth. A proportional tax is the kind that puts the same relative liability on all the taxpayers—i.e., where tax liability and income grow in the same scale. A progressive tax is characterized by a greater than proportional increase in the tax onus in regard to the growth in income, and a regressive tax is recognisable by a less than proportional rise in the relative liability. Hence, progressive taxes are seen as removing the lack of equality in income distribution, but regressive taxes are believed to result in increasing these inequalities.
The taxes that are normally thought to be progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, might become less so in the upper-income class—in particular if a taxpayer is permitted to reduce his tax base by claiming deductions or by excluding certain income components from his taxable income. Proportional tax rates when applied to lower-income demographics will also be more progressive if exemptions of a personal nature are made.
Income measured over the course of a given year might not necessarily offer the most accurate measure of taxpaying requirements. For example, transitory growth in income may be saved, and during temporary declines in income a taxpayer may elect to provide for consumption by reducing savings. Ergo, if taxation is held in comparison with “permanent income,” it can be less regressive (or more progressive) than if made comparable with annual income.
Sales taxes and excises (except those on luxuries) are mostly regressive, because the dissemination of one’s income consumed or spent on a specific good lowers as the amount of personal income rises. Poll taxes (also known as head taxes), levied as a fixed amount per capita, clearly are regressive.
It is complicated to dictate 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 nominating who bears the tax burden is dependant crucially on whether a national or a subnational (that is, provincial or state) tax is being considered.
In analysing the economic purpose of taxation, it is important to distinguish between various points of tax rates. The statutory rates will include those dictated in law; often these are marginal rates, but sometimes they are mean rates. Marginal income tax rates denote the fraction of incremental income taken by taxation when income grows 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 legislation usually contain graduated marginal rates—i.e., rates that grow as income grows. Careful analysis of marginal tax rates must review provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) falls by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points greater than specified within the statutory rates. Since marginal rates specify how after-tax income increases or decreases in response to changes in before-tax income, they are the appropriate ones for considering incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate applicable to income from business and capital, because it may depend on such considerations as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem grants that the marginal effective tax rate in income from capital is nothing under a consumption-based tax.
Average income tax rates signify the percentage of total income that is paid 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 rise with income, both because personal allowances are allowed for the taxpayer and dependents and also due to that marginal tax rates are graduated; on the other hand, preferential treatment of income received fundamentally by high-income households may dampen these effects, producing regressivity, as shown by average tax rates that lessen as income increases.
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