TCAM

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 impinges the same relative liability on each taxpayer—i.e., in the case where tax liability and income grow in equal proportion. A progressive tax is recognisable by a higher than proportional rise in the tax burden in regard to the growth in income, and a regressive tax is recognisable by a less than proportional growth in the relative liability. Therefore, progressive taxes are viewed as taking away inequity in income distribution, whereas regressive taxes are believed to result in an increase these inequalities.

The taxes that are usually thought to be progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, can become less so in the upper-income group—especially if a taxpayer is allowed to lower his tax base by declaring deductions or by taking some particular income aspects from his taxable income. Proportional tax rates when applied to lower-income classes could also be more progressive if personal exemptions are declared.

Income measured over a given period may not absolutely provide the most appropriate measure of taxpaying requirement. For example, transitory increases in income might be saved, and within temporary declines in income a taxpayer could choose to provide for consumption by taking from savings. So, if taxation is compared with “permanent income,” it will be less regressive (or more progressive) than if it is compared with annual income.

Sales taxes and excises (save luxuries) tend to be regressive, because the share of individual income consumed or spent on a specific good decreases as the amount of personal income grows. Poll taxes (also known as head taxes), calculated as a standard amount per capita, patently are regressive.

It is complicated to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of uncertainty around the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden depends essentially on whether a national or a subnational (that is, provincial or state) tax is being considered.

In assessing the economic effects of taxation, it is important to distinguish between differing concepts of tax rates. The statutory rates include those nominated in the law; usually these are marginal rates, but occasionally they are mean rates. Marginal income tax rates note the fraction of incremental income that is demanded by taxation when income grows by one dollar. Ergo, if tax burden increases by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax legislation commonly contain graduated marginal rates—i.e., rates that increase as income increases. Structured analysis of marginal tax rates must take into account provisions apart from the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) declines by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points greater than indicated by the statutory rates. Since marginal rates indicate how after-tax income changes in response to changes in before-tax income, they are the appropriate ones for appraising incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate applicable to income from business and capital, since it may rely on factors such 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 zero under a consumption-based tax.

Average income tax rates display the percentage 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 rises with income. Average income tax rates commonly grow with income, both because personal allowances are granted for the taxpayer and dependents and also because marginal tax rates are graduated; on the flip side, preferential treatment of income received predominantly by high-income households may dampen these effects, producing regressivity, as indicated by average tax rates that lower as income rises.

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