Proportional, Progressive, and Regressive taxes
Taxes can be distinguished by the impact they have on the allocation of income and wealth. A proportional tax is the kind of tax that imposes the same relative burden on all the taxpayers—i.e., in the case where tax liability and income move in relative proportion. A progressive tax is characterizable by a larger than proportional increase in the tax liability in relation to the rise in income, and a regressive tax is characterized by a less than proportional growth in the comparative burden. Hence, progressive taxes are seen as taking away inequity in income distribution, while regressive taxes are found to increase these inequalities.
The taxes that are often regarded as progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, can become less so in the upper-income categories—particularly if a taxpayer is permitted to reduce his tax base by nominating deductions or by excluding some income components from his taxable income. Proportional tax rates that are applied to lower-income categories would also be more progressive if personal exemptions are claimed.
Income measured over a given period does not absolutely offer the most accurate measure of taxpaying status. For example, transitory rises in income could be saved, and within temporary declines in income a taxpayer may choose to finance consumption by decreasing savings. So, if taxation is compared alongside “permanent income,” it can be less regressive (or more progressive) than when it is made comparable with annual income.
Sales taxes and excises (with the exception of luxuries) are mostly regressive, because the portion of individual income consumed or spent on a specific good lowers as the rate of personal income grows. Poll taxes (also termed head taxes), calculated as a flat amount per capita, patently are regressive.
It is complicated to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to the uncertainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden depends crucially on whether a national or a subnational (that is, provincial or state) tax is being decided.
In analysing the economic effects of taxation, it is necessary to distinguish between several concepts of tax rates. The statutory rates are specified in the legislation; generally speaking these are marginal rates, but occasionally they are median rates. Marginal income tax rates indicate the fraction of incremental income demanded by taxation when income grows by one dollar. So, if tax onus increases by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislature usually contain graduated marginal rates—i.e., rates that rise as income grows. Careful analysis of marginal tax rates must consider 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 specified 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 regarding incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate applied to income from business and capital, since it may be reliant on such factors 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 zero under a consumption-based tax.
Average income tax rates determine the fraction of total income that is paid in taxation. The pattern of average rates is the one that is relevant for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates commonly increase 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 predominantly by high-income households might swamp these effects, producing regressivity, as displayed by average tax rates that fall as income grows.
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