Proportional, Progressive, and Regressive taxes
Taxes are categorized by the effect they have on the allocation of income and wealth. A proportional tax is a tax that places the same relative onus on each taxpayer—i.e., when tax liability and income increase in equal proportion. A progressive tax is recognisable by a larger than proportional rise in the tax burden in relation to the rise in income, and a regressive tax is recognisable by a less than proportional rise in the comparable burden. So, progressive taxes are seen as taking away the lack of equality in income distribution, but regressive taxes are believed 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 nominally progressive, however, may become less so within the upper-income group—in particular if a taxpayer is able to reduce his tax base by claiming deductions or by excluding particular income parts from his taxable income. Proportional tax rates which are applied to lower-income categories can also be more progressive if such exemptions of a personal nature are claimed.
Income measured over the course of a given year might not necessarily give the most accurate measure of taxpaying requirements. For example, transitory growth in income may be saved, and within temporary declines in income a taxpayer could decide to finance consumption by taking from savings. So, if taxation is made comparable alongside “permanent income,” it would be less regressive (or more progressive) than if compared with annual income.
Sales taxes and excises (with the exception of those on luxuries) are generally regressive, because the dissemination of personal income consumed or spent on specific goods lessens as the amount of personal income increases. Poll taxes (also termed head taxes), nominated as a set amount per capita, obviously are regressive.
It is hard to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of uncertainty regarding 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 decided.
In analysing the economic purposes of taxation, it is relevant to differentiate between differing points of tax rates. The statutory rates are those dictated in law; commonly these are marginal rates, but for some cases they are average rates. Marginal income tax rates signify the fraction of incremental income that is demanded by taxation when income grows by one dollar. Therefore, if tax onus rises by 45 cents when income increases by one dollar, the marginal tax rate is 45 percent. Income tax laws commonly contain graduated marginal rates—i.e., rates that increase as income increases. Structured analysis of marginal tax rates need to take into account provisions other than 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 more than specified within the statutory rates. Since marginal rates display how after-tax income is changed in response to changes in before-tax income, they are the necessary ones for regarding incentive effects of taxation. It is even more complicated to understand the marginal effective tax rate to apply to income from business and capital, since it may be dependant on such factors 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 percentage of total income that is paid in taxation. The pattern of average rates is the one that is necessary for considering the distributional equity of taxation. Under a progressive income tax the average income tax rate rises 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; on the other hand, preferential treatment of income received predominantly by high-income households may dampen these effects, forcing regressivity, as shown by average tax rates that lessen as income rises.
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