Proportional, Progressive, and Regressive taxes
Taxes are categorized by the impact they have on the placement of income and wealth. A proportional tax is the kind of tax that puts the same relative burden on each taxpayer—i.e., where tax liability and income move in relative proportion. A progressive tax is characterized by a higher than proportional growth in the tax burden in regard to the increase in income, and a regressive tax is recognised by a less than proportional growth in the comparative liability. Therefore, progressive taxes are viewed as removing inequalities in income distribution, whereas 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 initially progressive, however, can become less so within the upper-income categories—in particular if a taxpayer is able to lessen his tax base by nominating deductions or by taking certain income components from his taxable income. Proportional tax rates when applied to lower-income classes could also be more progressive if personal exemptions are made.
Income measured over the period of a year may not necessarily give the most appropriate measure of taxpaying ability. For example, transitory rises in income may be saved, and during temporary declines in income a taxpayer may select to finance consumption by decreasing savings. So, if taxation is held in comparison with “permanent income,” it would be less regressive (or more progressive) than if compared with annual income.
Sales taxes and excises (excepting those on luxuries) are generally regressive, because the dissemination of individual income consumed or spent for a specific good decreases as the level of personal income grows. Poll taxes (also termed head taxes), nominated as a standard amount per capita, patently are regressive.
It is difficult to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to uncertainty around the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of deciding who bears the tax burden depends fundamentally on whether a national or a subnational (that is, provincial or state) tax is being decided.
In assessing the economic purposes of taxation, it is necessary to distinguish between varied ideas of tax rates. The statutory rates will include those nominated in legislation; commonly these are marginal rates, but in some cases they are median rates. Marginal income tax rates indicate the fraction of incremental income that is demanded by taxation when income grows by one dollar. Ergo, if tax liability grows by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax legislature usually contain graduated marginal rates—i.e., rates that grow as income increases. Structured analysis of marginal tax rates must 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 higher than nominated within the statutory rates. Since marginal rates signify how after-tax income changes in response to changes in before-tax income, they are the important ones for assessing incentive effects of taxation. It is even more complicated to understand the marginal effective tax rate applicable to income from business and capital, since it may be reliant on such factors as 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 determine the part of total income that is taken 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 rises with income. Average income tax rates commonly grow with income, both because personal allowances are allowed for the taxpayer and dependents and because marginal tax rates are graduated; on the other hand, preferential treatment of income received fundamentally by high-income households could swamp these effects, forcing regressivity, as shown by average tax rates that decline as income increases.
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