Proportional, Progressive, and Regressive taxes

Taxes are categorized by the effect they have on the allocation of income and wealth. A proportional tax is a kind that puts the same relative burden on each taxpayer—i.e., in the case where tax liability and income increase in relative levels. A progressive tax is recognisable by a greater than proportional growth in the tax onus in relation to the growth in income, and a regressive tax is characterizable by a less than proportional increase in the comparable liability. Thus, progressive taxes are thought of as reducing a lack of equality in income distribution, while regressive taxes are seen to increase these inequalities.

The taxes that are often considered progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, can become less so for the upper-income demographic—particularly if a taxpayer is allowed to reduce his tax base by claiming deductions or by removing some particular income aspects from his taxable income. Proportional tax rates which are applied to lower-income demographics will also be more progressive if such exemptions of a personal nature are declared.

Income measured over the course of a given period does not definitely come up with the most appropriate measure of taxpaying requirement. For example, transitory rises in income may be saved, and in temporary declines in income a taxpayer might choose to finance consumption by reducing savings. So, if taxation is compared alongside “permanent income,” it will be less regressive (or more progressive) than if made comparable with annual income.

Sales taxes and excises (with the exception of luxuries) are usually regressive, because the dissemination of individual income consumed or spent on specific goods lowers as the level of personal income increases. Poll taxes (also called head taxes), nominated as a fixed amount per capita, patently are regressive.

It is not simple to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to the uncertainty regarding 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 essentially on whether a national or a subnational (that is, provincial or state) tax is being decided.

In considering the economic effect of taxation, it is relevant to differentiate between various points of tax rates. The statutory rates are those nominated in the law; often these are marginal rates, but occasionally they are mean rates. Marginal income tax rates note the fraction of incremental income demanded by taxation when income increases by one dollar. So, if tax onus rises by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax regulations usually contain graduated marginal rates—i.e., rates that grow as income rises. Careful analysis of marginal tax rates must consider provisions apart from the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lowers by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points greater than specified by 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 important ones for considering incentive effects of taxation. It is even more complicated to know the marginal effective tax rate applicable to income from business and capital, since 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 holds that the marginal effective tax rate in income from capital is nil under a consumption-based tax.

Average income tax rates indicate the portion of total income that is demanded 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 increases with income. Average income tax rates commonly increase with income, both because personal allowances are permitted for the taxpayer and dependents and also due to that marginal tax rates are graduated; on the other hand, preferential treatment of income received predominantly by high-income households can swamp these effects, forcing regressivity, as displayed by average tax rates that decline as income increases.

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