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 a tax that puts the same relative onus on each taxpayer—i.e., in the case where tax liability and income grow in the same scale. A progressive tax is recognisable by a higher than proportional growth in the tax liability in relation to the increase in income, and a regressive tax is recognised by a less than proportional growth in the comparative onus. Therefore, progressive taxes are thought of as removing inequity in income distribution, but regressive taxes can cause an increase in these inequalities.
The taxes that are generally thought to be progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, might become less so for the upper-income group—especially if a taxpayer is permitted to reduce his tax base by claiming deductions or by taking some particular income components from his taxable income. Proportional tax rates when applied to lower-income groups would also be more progressive if exemptions of a personal nature are made.
Income measured over a given year might not definitely come up with the best measure of taxpaying ability. For example, transitory increases in income can be saved, and during temporary declines in income a taxpayer may opt to pay for consumption by decreasing savings. Therefore, if taxation is regarded along with “permanent income,” it should be less regressive (or more progressive) than if it is made comparable with annual income.
Sales taxes and excises (save those on luxuries) are generally regressive, because the share of individual income consumed or spent on a specific good lowers as the level of personal income grows. Poll taxes (also termed head taxes), calculated as a standard amount per capita, obviously are regressive.
It is hard to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to a lack of certainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden depends for the most part on whether a national or a subnational (that is, provincial or state) tax is being determined.
In analysing the economic effects of taxation, it is necessary to differentiate between varied ideas of tax rates. The statutory rates include those nominated in law; generally these are marginal rates, but for some cases they are mean rates. Marginal income tax rates denote the fraction of incremental income demanded by taxation when income rises by one dollar. Ergo, if tax burden increases by 45 cents when income increases 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. Structured analysis of marginal tax rates should regard provisions apart from the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) declines by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points greater than nominated in the statutory rates. Since marginal rates specify how after-tax income is changed in response to changes in before-tax income, they are the necessary ones for assessing incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate to apply to income from business and capital, since it may depend on considerations such 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 nothing under a consumption-based tax.
Average income tax rates show the percentage of total income that is taken in taxation. The pattern of average rates is the one that is relevant for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates commonly grow with income, both because personal allowances are granted for the taxpayer and dependents and because marginal tax rates are graduated; on the flip side, preferential treatment of income received predominantly by high-income households can dampen these effects, allowing regressivity, as indicated by average tax rates that lower as income increases.
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