Proportional, Progressive, and Regressive taxes
Taxes are distinguished by the effect they have on the placement of income and wealth. A proportional tax is the kind of tax that impinges the same relative burden on each taxpayer—i.e., where tax liability and income increase in equal scale. A progressive tax is characterizable by a more than proportional rise in the tax liability in regard to the rise in income, and a regressive tax is characterized by a less than proportional rise in the related liability. Thus, progressive taxes are regarded as taking away inequalities in income distribution, while regressive taxes can have the effect of increasing these inequalities.
The taxes that are normally considered progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, could become less so for the upper-income categories—particularly if a taxpayer is able to lessen his tax base by nominating deductions or by leaving out some certain income aspects from his taxable income. Proportional tax rates that are applied to lower-income demographics can also be more progressive if exemptions of a personal nature are made.
Income measured over a given year might not absolutely offer the most accurate measure of taxpaying status. For example, transitory rises in income might be saved, and during temporary declines in income a taxpayer might elect to provide for consumption by decreasing savings. Therefore, if taxation is regarded alongside “permanent income,” it should be less regressive (or more progressive) than when it is compared with annual income.
Sales taxes and excises (save luxuries) are mostly regressive, because the share of one’s income consumed or spent on specific goods declines as the rate of personal income is raised. Poll taxes (also known as head taxes), levied as a set amount per capita, patently are regressive.
It is hard to term corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally due to a lack of certainty regarding the ability of businesses to shift their tax expenses (see below Shifting and incidence). This difficulty of dictating who bears the tax burden is dependant for the most part on whether a national or a subnational (that is, provincial or state) tax is being determined.
In considering the economic effects of taxation, it is important to distinguish between various ideas of tax rates. The statutory rates are those dictated in legislature; generally speaking these are marginal rates, but sometimes they are median rates. Marginal income tax rates indicate the fraction of incremental income that is demanded by taxation when income rises 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 laws often contain graduated marginal rates—i.e., rates that grow as income rises. Heavy analysis of marginal tax rates need to review provisions other than the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lessens by 20 cents for each one-dollar rise in income, the marginal rate is 20 percentage points greater than specified in the statutory rates. Since marginal rates indicate how after-tax income is changed in response to changes in before-tax income, they are the relevant ones for considering incentive effects of taxation. It is even more difficult to nominate the marginal effective tax rate to apply to income from business and capital, since it may be dependant on considerations 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 indicate the part of total income that is demanded in taxation. The pattern of average rates is the one that is necessary 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 flip side, preferential treatment of income received fundamentally by high-income households can swamp these effects, allowing regressivity, as shown by average tax rates that decline as income rises.
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