Proportional, Progressive, and Regressive taxes
Taxes are differentiated by the effect they have on the allocation of income and wealth. A proportional tax is the kind that impinges the same relative requirement on each taxpayer—i.e., where tax liability and income grow in equal levels. A progressive tax is characterizable by a more than proportional rise in the tax onus in relation to the growth in income, and a regressive tax is characterizable by a less than proportional increase in the related onus. So, progressive taxes are regarded as taking away the lack of equality in income distribution, whereas regressive taxes are believed to have the effect of an increase in these inequalities.
The taxes that are usually thought to be progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, may become less so within the upper-income categories—in particular if a taxpayer is permitted to reduce his tax base by nominating deductions or by removing particular income aspects from his taxable income. Proportional tax rates that are applied to lower-income demographics will also be more progressive if exemptions of a personal nature are claimed.
Income measured over the course of a given period might not definitely offer the most accurate measure of taxpaying requirements. For example, transitory increases in income may be saved, and in temporary declines in income a taxpayer may decide to provide for consumption by decreasing savings. Therefore, if taxation is held in comparison alongside “permanent income,” it can be less regressive (or more progressive) than if compared with annual income.
Sales taxes and excises (excepting those on luxuries) are generally regressive, because the dissemination of individual income consumed or spent for specific goods decreases as the amount of personal income grows. Poll taxes (aka head taxes), levied as a standard 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 about the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden lays for the most part on whether a national or a subnational (that is, provincial or state) tax is being considered.
In considering the economic effect of taxation, it is essential to differentiate between varied concepts of tax rates. The statutory rates include those dictated in law; often these are marginal rates, but in some cases they are median rates. Marginal income tax rates signify the fraction of incremental income taken by taxation when income is increased by one dollar. Thus, if tax liability rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax laws often contain graduated marginal rates—i.e., rates that increase as income grows. Heavy analysis of marginal tax rates need to consider 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 growth in income, the marginal rate is 20 percentage points higher than nominated in the statutory rates. Since marginal rates specify how after-tax income is changed in response to changes in before-tax income, they are the important ones for considering incentive effects of taxation. It is even more difficult to realise the marginal effective tax rate applicable to income from business and capital, as 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 nothing under a consumption-based tax.
Average income tax rates indicate the portion of total income that is taken 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 rises with income. Average income tax rates commonly grow with income, both because personal allowances are permitted for the taxpayer and dependents and due to that marginal tax rates are graduated; conversely, preferential treatment of income received for the most part by high-income households could dwarf these effects, allowing regressivity, as shown by average tax rates that lessen as income rises.
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