Proportional, Progressive, and Regressive taxes

Taxes can be distinguished by the impact they have on the allocation of income and wealth. A proportional tax is the kind of tax that imposes the same relative onus on each taxpayer—i.e., in the case where tax liability and income grow in equal scale. A progressive tax is recognised by a larger than proportional growth in the tax liability relative to the growth in income, and a regressive tax is characterized by a less than proportional growth in the comparable burden. Hence, progressive taxes are regarded as removing inequalities in income distribution, while regressive taxes can have the effect of an increase in these inequalities.

The taxes that are often believed to be progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, might become less so within the upper-income class—especially if a taxpayer is able to reduce his tax base by nominating deductions or by excluding some income components from his taxable income. Proportional tax rates that are applied to lower-income classes can also be more progressive if personal exemptions are declared.

Income measured over the course of a given year may not absolutely give the most suitable measure of taxpaying requirement. For example, transitory increases in income may be saved, and within temporary declines in income a taxpayer may opt to provide for consumption by reducing savings. Ergo, if taxation is made comparable along with “permanent income,” it can be less regressive (or more progressive) than when made comparable with annual income.

Sales taxes and excises (save on luxuries) are mostly regressive, because the spread of own income consumed or spent on specific goods lessens as the level of personal income grows. Poll taxes (also known as head taxes), nominated as a fixed amount per capita, obviously are regressive.

It is not easy to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of a lack of certainty around the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden rests for the most part on whether a national or a subnational (that is, provincial or state) tax is being considered.

In considering the economic purposes of taxation, it is necessary to distinguish between differing points of tax rates. The statutory rates will be dictated in legislation; generally these are marginal rates, but for some cases they are average rates. Marginal income tax rates indicate the fraction of incremental income demanded by taxation when income is increased by one dollar. So, if tax onus increases by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax laws usually contain graduated marginal rates—i.e., rates that increase as income rises. Structured analysis of marginal tax rates should review 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 increase in income, the marginal rate is 20 percentage points more than specified 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 relevant ones for considering incentive effects of taxation. It is even more difficult to know the marginal effective tax rate applicable to income from business and capital, since it may rely on considerations such as the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem shows that the marginal effective tax rate in income from capital is nil under a consumption-based tax.

Average income tax rates display the portion of total income that is required in taxation. The pattern of average rates is the one that is important for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates generally increase with income, both because personal allowances are provided for the taxpayer and dependents and because marginal tax rates are graduated; on the other side of things, preferential treatment of income received for the most part by high-income households can swamp these effects, forcing regressivity, as indicated by average tax rates that lessen as income increases.

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