Proportional, Progressive, and Regressive taxes

Taxes can be differentiated by the impact they have on the distribution of income and wealth. A proportional tax is the kind of tax that places the same relative requirement on all taxpayers—i.e., in the case where tax liability and income move in equal levels. A progressive tax is recognisable by a higher than proportional rise in the tax burden relative to the increase in income, and a regressive tax is characterizable by a less than proportional rise in the relative liability. Hence, progressive taxes are viewed as fighting inequity in income distribution, whereas regressive taxes can have the result of 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 categorically progressive, however, might become less so within the upper-income class—in particular if a taxpayer is permitted to lessen his tax base by claiming deductions or by removing certain income elements from his taxable income. Proportional tax rates if applied to lower-income categories can also be more progressive if exemptions of a personal nature are made.

Income measured over the period of a given year does not definitely give the most suitable measure of taxpaying status. For example, transitory rises in income might be saved, and during temporary declines in income a taxpayer might elect to pay for consumption by decreasing savings. So, if taxation is made comparable along with “permanent income,” it would be less regressive (or more progressive) than when it is held in comparison with annual income.

Sales taxes and excises (save those on luxuries) tend to be regressive, because the share of own income consumed or spent for specific goods lessens as the amount of personal income increases. Poll taxes (aka head taxes), nominated as a fixed amount per capita, clearly are regressive.

It is not simple to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to uncertainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of deciding who bears the tax burden is dependant fundamentally on whether a national or a subnational (that is, provincial or state) tax is being determined.

In regarding the economic effects of taxation, it is relevant to distinguish between varied concepts of tax rates. The statutory rates will be dictated in the law; commonly these are marginal rates, but in some cases they are mean rates. Marginal income tax rates note the fraction of incremental income taken by taxation when income rises by one dollar. Thus, if tax burden increases by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax statutes usually contain graduated marginal rates—i.e., rates that rise as income increases. Heavy analysis of marginal tax rates must regard provisions apart from 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 higher than indicated in the statutory rates. Since marginal rates indicate how after-tax income moves in response to changes in before-tax income, they are the necessary ones for considering incentive effects of taxation. It is even more complicated to understand the marginal effective tax rate applied to income from business and capital, as it may be dependant on such considerations 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 show the portion of total income that is demanded in taxation. The pattern of average rates is the one that is necessary for assessing the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates generally rise with income, both because personal allowances are permitted for the taxpayer and dependents and also because marginal tax rates are graduated; on the other hand, preferential treatment of income received predominantly by high-income households may swamp these effects, producing regressivity, as signified by average tax rates that decline as income grows.

For MYOB Brisbane expert advice, contact Stone Consulting today. Stone Consulting also runs MYOB training in Brisbane.

Sphere: Related Content