Proportional, Progressive, and Regressive taxes
Taxes are categorized by the impact they have on the placement of income and wealth. A proportional tax is the kind of tax that places the same relative onus on every taxpayer—i.e., in the case where tax liability and income increase in the same scale. A progressive tax is characterized by a higher than proportional rise in the tax onus in relation to the rise in income, and a regressive tax is recognisable by a less than proportional rise in the comparative burden. Thus, progressive taxes are regarded as removing the lack of equality in income distribution, but regressive taxes are believed to have the effect of increasing these inequalities.
The taxes that are usually regarded as progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, could become less so in the upper-income class—especially if a taxpayer is able to reduce his tax base by nominating deductions or by taking some income parts from his taxable income. Proportional tax rates that are applied to lower-income demographics can also be more progressive if such personal exemptions are made.
Income measured over the period of a given year does not necessarily come up with the most appropriate measure of taxpaying requirement. For example, transitory rises in income might be saved, and during temporary declines in income a taxpayer may select to finance consumption by reducing savings. Ergo, if taxation is compared with “permanent income,” it should be less regressive (or more progressive) than if it is made comparable with annual income.
Sales taxes and excises (except luxuries) tend to be regressive, because the share of own income consumed or spent on specific goods lessens as the amount of personal income rises. Poll taxes (also called head taxes), levied as a standard amount per capita, obviously are regressive.
It is hard to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of uncertainty surrounding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden lays crucially on whether a national or a subnational (that is, provincial or state) tax is being decided.
In considering the economic purposes of taxation, it is necessary to distinguish between several ideas of tax rates. The statutory rates are those nominated in legislation; commonly these are marginal rates, but in some cases they are average rates. Marginal income tax rates indicate the fraction of incremental income that is demanded by taxation when income grows by one dollar. Hence, if tax liability rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislation usually contain graduated marginal rates—i.e., rates that increase as income rises. Careful analysis of marginal tax rates must consider provisions in addition to 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 specified within the statutory rates. Since marginal rates specify how after-tax income increases or decreases in response to changes in before-tax income, they are the relevant ones for considering incentive effects of taxation. It is even more difficult to understand the marginal effective tax rate applied to income from business and capital, because it may be reliant on such considerations 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 nothing under a consumption-based tax.
Average income tax rates indicate the percentage of total income that is paid in taxation. The pattern of average rates is the one that is relevant 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 grow with income, both because personal allowances are allowed for the taxpayer and dependents and also because marginal tax rates are graduated; on the other side of things, preferential treatment of income received mostly by high-income households might dwarf these effects, producing regressivity, as indicated by average tax rates that decrease as income increases.
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