Proportional, Progressive, and Regressive taxes

Taxes are differentiated by the impact they have on the distribution of income and wealth. A proportional tax is the kind of tax that puts the same relative onus on every taxpayer—i.e., when tax liability and income grow in equal proportion. A progressive tax is characterized by a higher than proportional increase in the tax liability relative to the growth in income, and a regressive tax is characterized by a less than proportional increase in the relative liability. Ergo, progressive taxes are seen as fighting inequalities in income distribution, but regressive taxes are seen to have the result of increasing 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, can become less so within the upper-income group—in particular if a taxpayer is permitted to reduce his tax base by claiming deductions or by removing some certain income parts from his taxable income. Proportional tax rates when applied to lower-income classes would also be more progressive if such exemptions of a personal nature are made.

Income measured over the period of a given year may not definitely give the most suitable measure of taxpaying requirements. For example, transitory growth in income might be saved, and within temporary declines in income a taxpayer might choose to pay for consumption by decreasing savings. Ergo, if taxation is made comparable with “permanent income,” it should be less regressive (or more progressive) than when compared with annual income.

Sales taxes and excises (with the exception of luxuries) are generally regressive, because the share of own income consumed or spent for a specific good lessens as the level of personal income increases. Poll taxes (also termed head taxes), levied as a flat amount per capita, patently are regressive.

It is hard to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of 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 regarding the economic effect of taxation, it is essential to differentiate between differing concepts of tax rates. The statutory rates will include those dictated in law; generally these are marginal rates, but occasionally they are median rates. Marginal income tax rates denote the fraction of incremental income that is demanded by taxation when income rises by one dollar. Thus, if tax liability increases by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax statutes commonly contain graduated marginal rates—i.e., rates that grow as income grows. 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) declines by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points greater than nominated within the statutory rates. Since marginal rates display how after-tax income increases or decreases in response to changes in before-tax income, they are the necessary ones for regarding incentive effects of taxation. It is even more complicated to realise the marginal effective tax rate applicable to income from business and capital, since it may depend 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 indicate the percentage of total income that is demanded in taxation. The pattern of average rates is the one that is relevant for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates generally grow with income, both because personal allowances are provided for the taxpayer and dependents and also due to that marginal tax rates are graduated; on the other side of things, preferential treatment of income received for the most part by high-income households might dampen these effects, forcing regressivity, as indicated by average tax rates that decline as income increases.

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