Proportional, Progressive, and Regressive taxes
Taxes can be distinguished by the effect they have on the allocation of income and wealth. A proportional tax is a tax that places the same relative liability on each taxpayer—i.e., in the case where tax liability and income grow in the same scale. A progressive tax is recognisable by a more than proportional growth in the tax burden in regard to the rise in income, and a regressive tax is recognisable by a less than proportional rise in the relative liability. Hence, progressive taxes are thought of as fighting inequity in income distribution, whereas regressive taxes may result in increasing these inequalities.
The taxes that are generally thought to be progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, might become less so for the upper-income group—in particular if a taxpayer is allowed to reduce his tax base by declaring deductions or by removing some income components from his taxable income. Proportional tax rates that are applied to lower-income classes will also be more progressive if personal exemptions are claimed.
Income measured over the course of a given year does not definitely offer the most appropriate measure of taxpaying ability. For example, transitory rises in income may be saved, and in temporary declines in income a taxpayer could elect to finance consumption by decreasing savings. Thus, if taxation is held in comparison alongside “permanent income,” it can be less regressive (or more progressive) than when it is compared with annual income.
Sales taxes and excises (with the exception of those on luxuries) tend to be regressive, because the portion of personal income consumed or spent on specific goods lessens as the rate of personal income grows. Poll taxes (aka head taxes), levied as a flat amount per capita, clearly are regressive.
It is not simple to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of the lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of nominating who bears the tax burden rests fundamentally on whether a national or a subnational (that is, provincial or state) tax is being debated.
In regarding the economic effect of taxation, it is essential to distinguish between differing points of tax rates. The statutory rates include those specified in legislature; generally these are marginal rates, but for some cases they are mean rates. Marginal income tax rates note the fraction of incremental income that is demanded by taxation when income rises by one dollar. Thus, if tax burden grows by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax laws generally contain graduated marginal rates—i.e., rates that rise as income increases. Heavy analysis of marginal tax rates must 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 increase in income, the marginal rate is 20 percentage points more than indicated in 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 appropriate ones for regarding incentive effects of taxation. It is even more complicated to know the marginal effective tax rate applied to income from business and capital, because it may be reliant on factors including 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 nothing under a consumption-based tax.
Average income tax rates display the part of total income that is paid in taxation. The pattern of average rates is the one that is important for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates commonly grow with income, both because personal allowances are allowed for the taxpayer and dependents and due to that marginal tax rates are graduated; conversely, preferential treatment of income received mostly by high-income households could dampen these effects, forcing regressivity, as indicated by average tax rates that lessen as income grows.
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