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 the kind of tax that imposes the same relative onus on each taxpayer—i.e., in the case where tax liability and income increase in relative proportion. A progressive tax is characterized by a higher than proportional growth in the tax burden in regard to the rise in income, and a regressive tax is recognised by a less than proportional increase in the related burden. Thus, progressive taxes are seen as fighting the lack of equality in income distribution, but regressive taxes can have the effect of an increase in these inequalities.
The taxes that are generally regarded as progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, might become less so within the upper-income categories—especially if a taxpayer is able to lower his tax base by claiming deductions or by leaving out certain income components from his taxable income. Proportional tax rates when applied to lower-income classes could also be more progressive if such personal exemptions are claimed.
Income measured over the period of a year may not absolutely provide the most appropriate measure of taxpaying requirement. For example, transitory growth in income can be saved, and during temporary declines in income a taxpayer may opt to pay for consumption by taking from savings. Thus, if taxation is made comparable with “permanent income,” it would be less regressive (or more progressive) than when made comparable with annual income.
Sales taxes and excises (excepting those on luxuries) are usually regressive, because the spread of one’s income consumed or spent on a specific good decreases as the amount of personal income increases. Poll taxes (also known as head taxes), levied as a fixed amount per capita, obviously are regressive.
It is not easy to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, due to uncertainty around 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 decided.
In considering the economic effects of taxation, it is relevant to differentiate between various concepts of tax rates. The statutory rates are specified in law; generally these are marginal rates, but occasionally they are average rates. Marginal income tax rates signify the fraction of incremental income taken by taxation when income grows by one dollar. So, if tax liability grows by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislature generally contain graduated marginal rates—i.e., rates that rise as income rises. Structured 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 rise in income, the marginal rate is 20 percentage points greater than specified within the statutory rates. Since marginal rates signify how after-tax income increases or decreases in response to changes in before-tax income, they are the necessary ones for regarding incentive effects of taxation. It is even more difficult to know the marginal effective tax rate to apply to income from business and capital, since it may depend on factors including the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem grants 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 demanded 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 grows with income. Average income tax rates usually rise with income, both because personal allowances are allowed for the taxpayer and dependents and also because marginal tax rates are graduated; on the other hand, preferential treatment of income received for the most part by high-income households may swamp these effects, producing regressivity, as shown by average tax rates that lower as income grows.
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