Proportional, Progressive, and Regressive taxes
Taxes are differentiated by the effect they have on the distribution of income and wealth. A proportional tax is a tax that impinges the same relative onus on each taxpayer—i.e., when tax liability and income move in relative scale. A progressive tax is recognised by a greater than proportional growth in the tax liability in relation to the rise in income, and a regressive tax is recognisable by a less than proportional rise in the related burden. Thus, progressive taxes are viewed as reducing a lack of equality in income distribution, whereas regressive taxes are found to have the effect of increasing these inequalities.
The taxes that are usually thought to be progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, could become less so within the upper-income class—particularly if a taxpayer is permitted to reduce his tax base by nominating deductions or by excluding some income parts from his taxable income. Proportional tax rates when applied to lower-income categories would also be more progressive if such personal exemptions are declared.
Income measured over the course of a given year may not absolutely provide the best measure of taxpaying ability. For example, transitory increases in income might be saved, and during temporary declines in income a taxpayer may elect to pay for consumption by taking from savings. Thus, if taxation is made comparable along with “permanent income,” it would be less regressive (or more progressive) than if compared with annual income.
Sales taxes and excises (excepting luxuries) are mostly regressive, because the dissemination of own income consumed or spent on specific goods declines as the rate of personal income grows. Poll taxes (also called head taxes), calculated as a standard amount per capita, clearly are regressive.
It is complicated to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of the uncertainty surrounding 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 necessary to differentiate between several ideas of tax rates. The statutory rates include those nominated in legislature; generally speaking 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 grows by one dollar. Therefore, if tax burden rises by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislature often contain graduated marginal rates—i.e., rates that grow as income increases. Heavy analysis of marginal tax rates need to consider provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) declines by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points higher than nominated by the statutory rates. Since marginal rates indicate how after-tax income is changed in response to changes in before-tax income, they are the appropriate ones for considering incentive effects of taxation. It is even more complicated to understand the marginal effective tax rate applicable to income from business and capital, as it may rely on considerations such as 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 nothing under a consumption-based tax.
Average income tax rates determine the percentage of total income that is demanded 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 grows with income. Average income tax rates commonly grow with income, both because personal allowances are permitted for the taxpayer and dependents and due to that marginal tax rates are graduated; on the other side of things, preferential treatment of income received fundamentally by high-income households may dwarf these effects, forcing regressivity, as signified by average tax rates that lower as income increases.
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