Proportional, Progressive, and Regressive taxes
Taxes can be distinguished by the effect they have on the distribution of income and wealth. A proportional tax is a tax that places the same relative burden on every taxpayer—i.e., when tax liability and income increase in relative scale. A progressive tax is recognised by a more than proportional rise in the tax liability in regard to the rise in income, and a regressive tax is recognised by a less than proportional rise in the related onus. Thus, progressive taxes are thought of as reducing inequalities in income distribution, but regressive taxes are seen to have the effect of increasing these inequalities.
The taxes that are generally believed to be progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, can become less so for the upper-income categories—particularly if a taxpayer is able to reduce his tax base by claiming deductions or by leaving out particular income aspects from his taxable income. Proportional tax rates if applied to lower-income groups could also be more progressive if such personal exemptions are made.
Income measured over the period of a year may not necessarily offer the most accurate measure of taxpaying status. For example, transitory rises in income might be saved, and in temporary declines in income a taxpayer may opt to provide for consumption by decreasing savings. Ergo, if taxation is compared with “permanent income,” it can be less regressive (or more progressive) than if it is made comparable with annual income.
Sales taxes and excises (except luxuries) are generally regressive, because the portion of own income consumed or spent for a specific good declines as the level of personal income increases. Poll taxes (also known as head taxes), calculated as a standard amount per capita, patently are regressive.
It is hard to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of a lack of certainty about the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of determining who bears the tax burden is dependant essentially on whether a national or a subnational (that is, provincial or state) tax is being debated.
In regarding the economic purpose of taxation, it is important to differentiate between several ideas of tax rates. The statutory rates are those specified in legislature; commonly these are marginal rates, but for some cases they are average rates. Marginal income tax rates denote the fraction of incremental income demanded by taxation when income grows by one dollar. Therefore, if tax burden grows by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax statutes often contain graduated marginal rates—i.e., rates that increase as income grows. Structured analysis of marginal tax rates should consider provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lowers by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points more than indicated in the statutory rates. Since marginal rates indicate how after-tax income increases or decreases in response to changes in before-tax income, they are the necessary ones for assessing incentive effects of taxation. It is even more complicated to know the marginal effective tax rate applicable to income from business and capital, because it may depend 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 display the percentage of total income that is required in taxation. The pattern of average rates is the one that is in consideration for appraising the distributional equity of taxation. Under a progressive income tax the average income tax rate grows with income. Average income tax rates usually grow with income, both because personal allowances are permitted for the taxpayer and dependents and also because marginal tax rates are graduated; conversely, preferential treatment of income received predominantly by high-income households can swamp these effects, forcing regressivity, as displayed by average tax rates that decline as income grows.
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