Proportional, Progressive, and Regressive taxes

Taxes are distinguished by the impact they have on the placement of income and wealth. A proportional tax is the kind of tax that impinges the same relative burden on all the taxpayers—i.e., where tax liability and income increase in relative levels. A progressive tax is characterized by a greater than proportional increase in the tax burden in relation to the increase in income, and a regressive tax is recognisable by a less than proportional growth in the comparable onus. So, progressive taxes are seen as removing inequalities in income distribution, but regressive taxes might cause an increase in these inequalities.

The taxes that are generally considered progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, can become less so in the upper-income class—in particular if a taxpayer is permitted to reduce his tax base by declaring deductions or by excluding certain income components from his taxable income. Proportional tax rates if applied to lower-income classes could also be more progressive if exemptions of a personal nature are declared.

Income measured over the period of a given year does not absolutely provide the most suitable measure of taxpaying ability. For example, transitory growth in income might be saved, and within temporary declines in income a taxpayer might elect to finance consumption by taking from savings. Ergo, if taxation is made comparable with “permanent income,” it would be less regressive (or more progressive) than if held in comparison with annual income.

Sales taxes and excises (except those on luxuries) tend to be regressive, because the portion of one’s income consumed or spent on specific goods lowers as the level of personal income grows. Poll taxes (also known as head taxes), levied as a flat amount per capita, obviously are regressive.

It is hard to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of the uncertainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden is dependant fundamentally on whether a national or a subnational (that is, provincial or state) tax is being decided.

In analysing the economic purposes of taxation, it is relevant to differentiate between differing points of tax rates. The statutory rates include those dictated in the legislation; commonly these are marginal rates, but sometimes they are average rates. Marginal income tax rates indicate the fraction of incremental income that is demanded by taxation when income rises 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 statutes generally contain graduated marginal rates—i.e., rates that grow as income rises. Structured analysis of marginal tax rates are required to review 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 nominated by the statutory rates. Since marginal rates display how after-tax income moves in response to changes in before-tax income, they are the relevant ones for regarding 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 depend on factors including 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 nil under a consumption-based tax.

Average income tax rates indicate the fraction of total income that is demanded in taxation. The pattern of average rates is the one that is necessary 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 granted for the taxpayer and dependents and also because marginal tax rates are graduated; on the other hand, preferential treatment of income received for the most part by high-income households can dampen these effects, producing regressivity, as displayed by average tax rates that decline as income grows.

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