Proportional, Progressive, and Regressive taxes
Thursday, July 8th, 2010Taxes can be categorized by the impact they have on the allocation of income and wealth. A proportional tax is one that impinges the same relative liability on all taxpayers—i.e., where tax liability and income move in relative proportion. A progressive tax is recognisable by a more than proportional growth in the tax liability relative to the growth in income, and a regressive tax is characterized by a less than proportional increase in the comparative liability. Thus, progressive taxes are seen as reducing inequalities in income distribution, whereas regressive taxes are seen to have the effect of an increase in these inequalities.
The taxes that are generally believed to be progressive include individual income taxes and estate taxes. Income taxes that are declarably progressive, however, may become less so in the upper-income group—particularly if a taxpayer is able to lower his tax base by nominating deductions or by removing some certain income components from his taxable income. Proportional tax rates when applied to lower-income demographics could also be more progressive if such exemptions of a personal nature are made.
Income measured over the period of a given year may not necessarily give the most appropriate measure of taxpaying ability. For example, transitory growth in income might be saved, and in temporary declines in income a taxpayer may opt to provide for consumption by reducing savings. So, if taxation is made comparable alongside “permanent income,” it can be less regressive (or more progressive) than when it is made comparable with annual income.
Sales taxes and excises (excepting those on luxuries) tend to be regressive, because the spread of one’s income consumed or spent for a specific good lessens as the level of personal income grows. Poll taxes (also called head taxes), calculated as a flat amount per capita, clearly are regressive.
It is not simple to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of the lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of deciding who bears the tax burden depends fundamentally on whether a national or a subnational (that is, provincial or state) tax is being determined.
In considering the economic effect of taxation, it is important to differentiate between varied concepts of tax rates. The statutory rates will include those dictated in the law; usually these are marginal rates, but occasionally they are average rates. Marginal income tax rates indicate the fraction of incremental income that is taken by taxation when income is increased by one dollar. Thus, if tax onus grows by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax laws commonly contain graduated marginal rates—i.e., rates that increase as income rises. Structured analysis of marginal tax rates should review provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) reduces by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points greater than indicated in the statutory rates. Since marginal rates display how after-tax income moves in response to changes in before-tax income, they are the relevant ones for assessing incentive effects of taxation. It is even more difficult to realise the marginal effective tax rate applicable to income from business and capital, since it may be dependant on factors including the structure of depreciation allowances, the deductibility of interest, and the provisions for inflation adjustment. A basic economic theorem shows that the marginal effective tax rate in income from capital is zero under a consumption-based tax.
Average income tax rates signify the portion of total income that is required 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 generally increase with income, both because personal allowances are granted for the taxpayer and dependents and because marginal tax rates are graduated; conversely, preferential treatment of income received predominantly by high-income households might dampen these effects, producing regressivity, as shown by average tax rates that decrease as income rises.
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