Proportional, Progressive, and Regressive taxes
Taxes can be categorized by the impact they have on the allocation of income and wealth. A proportional tax is a kind that imposes the same relative onus on every taxpayer—i.e., when tax liability and income grow in equal proportion. A progressive tax is recognisable by a more than proportional growth in the tax burden relative to the rise in income, and a regressive tax is recognised by a less than proportional growth in the related burden. Thus, progressive taxes are regarded as removing a lack of equality in income distribution, while regressive taxes are seen to result in increasing these inequalities.
The taxes that are often believed to be progressive include individual income taxes and estate taxes. Income taxes that are initially progressive, however, may become less so for the upper-income class—in particular if a taxpayer is able to lessen his tax base by declaring deductions or by taking some certain income parts from his taxable income. Proportional tax rates when applied to lower-income demographics will also be more progressive if such exemptions of a personal nature are declared.
Income measured over the period of a given year might not definitely offer the most suitable measure of taxpaying requirement. For example, transitory rises in income might be saved, and in temporary declines in income a taxpayer might opt to pay for consumption by decreasing savings. So, if taxation is held in comparison with “permanent income,” it should be less regressive (or more progressive) than if held in comparison with annual income.
Sales taxes and excises (except luxuries) tend to be regressive, because the share of personal income consumed or spent on specific goods lessens as the level of personal income rises. Poll taxes (also called head taxes), calculated as a flat amount per capita, clearly are regressive.
It is hard to dictate corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to the uncertainty surrounding 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 crucially on whether a national or a subnational (that is, provincial or state) tax is being determined.
In analysing the economic effect of taxation, it is essential to distinguish between several ideas of tax rates. The statutory rates include those specified in law; generally speaking 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. Hence, if tax liability grows by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax legislature often contain graduated marginal rates—i.e., rates that increase as income rises. Structured 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) decreases by 20 cents for each one-dollar increase in income, the marginal rate is 20 percentage points greater than specified by the statutory rates. Since marginal rates specify how after-tax income increases or decreases in response to changes in before-tax income, they are the appropriate ones for regarding incentive effects of taxation. It is even more difficult to understand the marginal effective tax rate applicable to income from business and capital, as it may be dependant on considerations 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 zero under a consumption-based tax.
Average income tax rates display the percentage of total income that is paid in taxation. The pattern of average rates is the one that is important for judging the distributional equity of taxation. Under a progressive income tax the average income tax rate increases with income. Average income tax rates usually rise with income, both because personal allowances are allowed for the taxpayer and dependents and also because marginal tax rates are graduated; on the flip side, preferential treatment of income received mostly by high-income households may swamp these effects, forcing regressivity, as shown by average tax rates that fall as income rises.
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