TCAM

Taxes can be differentiated by the impact they have on the allocation of income and wealth. A proportional tax is one that applies the same relative burden on all the taxpayers—i.e., when tax liability and income grow in relative levels. A progressive tax is characterized by a more than proportional growth in the tax burden in relation to the increase in income, and a regressive tax is characterizable by a less than proportional increase in the relative burden. So, progressive taxes are viewed as removing a lack of equality in income distribution, while regressive taxes may result in an increase these inequalities.

The taxes that are usually considered progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, might become less so within the upper-income categories—in particular if a taxpayer is allowed to reduce his tax base by claiming deductions or by removing particular income components from his taxable income. Proportional tax rates which are applied to lower-income classes could also be more progressive if such exemptions of a personal nature are claimed.

Income measured over a given year might not absolutely provide the most suitable measure of taxpaying requirements. For example, transitory growth in income can be saved, and within temporary declines in income a taxpayer may elect to provide for consumption by decreasing savings. Ergo, if taxation is made comparable alongside “permanent income,” it will be less regressive (or more progressive) than when it is made comparable with annual income.

Sales taxes and excises (excepting luxuries) are usually regressive, because the share of personal income consumed or spent for a specific good decreases as the level of personal income is raised. Poll taxes (also termed head taxes), nominated as a set amount per capita, clearly are regressive.

It is not simple to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of uncertainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden depends crucially on whether a national or a subnational (that is, provincial or state) tax is being debated.

In considering the economic effects of taxation, it is important to distinguish between various points of tax rates. The statutory rates include those dictated in the law; often these are marginal rates, but for some cases they are mean rates. Marginal income tax rates signify the fraction of incremental income demanded by taxation when income is increased by one dollar. So, if tax onus grows by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax statutes usually contain graduated marginal rates—i.e., rates that rise as income grows. Careful analysis of marginal tax rates should take into account 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 more than nominated within the statutory rates. Since marginal rates specify how after-tax income is changed 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 nominate the marginal effective tax rate applied to income from business and capital, as 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 grants that the marginal effective tax rate in income from capital is nothing under a consumption-based tax.

Average income tax rates display the portion of total income that is paid in taxation. The pattern of average rates is the one that is necessary for assessing 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 provided for the taxpayer and dependents and because marginal tax rates are graduated; on the flip side, preferential treatment of income received fundamentally by high-income households can swamp these effects, forcing regressivity, as shown by average tax rates that lessen as income increases.

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