Proportional, Progressive, and Regressive taxes
Taxes can be differentiated by the effect they have on the allocation of income and wealth. A proportional tax is a kind that places the same relative onus on all the taxpayers—i.e., in the case where tax liability and income increase in the same levels. A progressive tax is characterized by a higher than proportional increase in the tax burden in regard to the increase in income, and a regressive tax is recognised by a less than proportional growth in the related liability. So, progressive taxes are seen as removing inequity in income distribution, while regressive taxes are found to result in an increase these inequalities.
The taxes that are often considered progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, could become less so for the upper-income categories—particularly if a taxpayer is permitted to lessen his tax base by claiming deductions or by leaving out some certain income aspects from his taxable income. Proportional tax rates if applied to lower-income groups would also be more progressive if such exemptions of a personal nature are made.
Income measured over the period of a given year might not absolutely give the most accurate measure of taxpaying requirements. For example, transitory rises in income may be saved, and within temporary declines in income a taxpayer could decide to pay for consumption by reducing savings. Therefore, if taxation is held in comparison along with “permanent income,” it would be less regressive (or more progressive) than if held in comparison with annual income.
Sales taxes and excises (excepting those on luxuries) are generally regressive, because the portion of personal income consumed or spent for specific goods decreases as the level of personal income rises. Poll taxes (aka head taxes), nominated as a fixed 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 the uncertainty 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 essentially on whether a national or a subnational (that is, provincial or state) tax is being decided.
In assessing the economic effect of taxation, it is essential to differentiate between differing concepts of tax rates. The statutory rates are those nominated in legislation; commonly these are marginal rates, but occasionally they are median rates. Marginal income tax rates indicate the fraction of incremental income that is taken by taxation when income grows 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 commonly contain graduated marginal rates—i.e., rates that rise as income grows. Heavy analysis of marginal tax rates need to review provisions other than 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 more 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 appropriate ones for appraising incentive effects of taxation. It is even more complicated to know the marginal effective tax rate to apply to income from business and capital, as it may depend on considerations including 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 nothing under a consumption-based tax.
Average income tax rates indicate the part of total income that is required in taxation. The pattern of average rates is the one that is necessary for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates usually increase with income, both because personal allowances are granted for the taxpayer and dependents and also because marginal tax rates are graduated; on the flip side, preferential treatment of income received for the most part by high-income households may dampen these effects, forcing regressivity, as signified by average tax rates that fall as income grows.
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