Proportional, Progressive, and Regressive taxes
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Taxes can be categorized by the impact they have on the placement of income and wealth. A proportional tax is a kind that applies the same relative liability on every taxpayer—i.e., where tax liability and income grow in equal scale. A progressive tax is characterized by a greater than proportional growth in the tax onus relative to the rise in income, and a regressive tax is characterized by a less than proportional rise in the comparable liability. So, progressive taxes are seen as fighting a lack of equality in income distribution, while regressive taxes are found to result in increasing these inequalities.
The taxes that are often thought to be progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, might become less so for the upper-income group—in particular if a taxpayer is able to reduce his tax base by claiming deductions or by taking certain income aspects from his taxable income. Proportional tax rates which are applied to lower-income classes can also be more progressive if personal exemptions are made.
Income measured over the period of a given year might not necessarily offer the most suitable measure of taxpaying status. For example, transitory increases in income could be saved, and during temporary declines in income a taxpayer could choose to provide for consumption by reducing savings. Therefore, if taxation is held in comparison alongside “permanent income,” it would be less regressive (or more progressive) than when compared with annual income.
Sales taxes and excises (save on luxuries) are mostly regressive, because the share of individual income consumed or spent on a specific good declines as the level of personal income is raised. Poll taxes (also known as head taxes), nominated as a set amount per capita, clearly are regressive.
It is complicated to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of the uncertainty around the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden rests crucially on whether a national or a subnational (that is, provincial or state) tax is being decided.
In assessing the economic purpose of taxation, it is important to distinguish between several concepts of tax rates. The statutory rates are those dictated in legislation; often these are marginal rates, but in some cases they are average rates. Marginal income tax rates denote the fraction of incremental income that is demanded by taxation when income increases by one dollar. Ergo, if tax liability increases by 45 cents when income rises 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 increases. Heavy analysis of marginal tax rates must regard provisions as well as the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) reduces by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points greater than nominated within the statutory rates. Since marginal rates indicate how after-tax income increases or decreases in response to changes in before-tax income, they are the relevant ones for assessing incentive effects of taxation. It is even more difficult to know the marginal effective tax rate applied to income from business and capital, because it may depend on considerations such 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 zero under a consumption-based tax.
Average income tax rates determine the part of total income that is demanded in taxation. The pattern of average rates is the one that is important for assessing the distributional equity of taxation. Under a progressive income tax the average income tax rate rises with income. Average income tax rates commonly grow 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 mostly by high-income households may dampen these effects, allowing regressivity, as signified by average tax rates that decrease as income increases.
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