Proportional, Progressive, and Regressive taxes
Taxes can be differentiated by the impact they have on the allocation of income and wealth. A proportional tax is a tax that imposes the same relative requirement on all taxpayers—i.e., where tax liability and income increase in the same proportion. A progressive tax is recognisable by a larger than proportional rise in the tax burden relative to the rise in income, and a regressive tax is recognised by a less than proportional increase in the comparable burden. So, progressive taxes are thought of as fighting inequalities in income distribution, while regressive taxes may result in increasing these inequalities.
The taxes that are often thought to be progressive include individual income taxes and estate taxes. Income taxes that are categorically progressive, however, can become less so within the upper-income class—especially if a taxpayer is permitted to reduce his tax base by declaring deductions or by removing some particular income components from his taxable income. Proportional tax rates when applied to lower-income classes would also be more progressive if exemptions of a personal nature are claimed.
Income measured over the period of a given year might not necessarily offer the best measure of taxpaying requirement. For example, transitory increases in income could be saved, and within temporary declines in income a taxpayer might elect to pay for consumption by taking from savings. Thus, if taxation is held in comparison alongside “permanent income,” it will be less regressive (or more progressive) than when it is made comparable with annual income.
Sales taxes and excises (save on luxuries) tend to be regressive, because the share of own income consumed or spent on a specific good declines as the rate of personal income is raised. Poll taxes (also termed head taxes), nominated as a standard amount per capita, patently are regressive.
It is not simple to determine corporate income taxes and taxes on business as progressive, regressive, or proportionate, because of 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 rests essentially 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 distinguish between varied ideas of tax rates. The statutory rates include those specified in law; usually these are marginal rates, but sometimes they are average rates. Marginal income tax rates denote the fraction of incremental income that is taken by taxation when income is increased by one dollar. Hence, if tax onus rises by 45 cents when income rises by one dollar, the marginal tax rate is 45 percent. Income tax statutes generally contain graduated marginal rates—i.e., rates that rise as income rises. Careful analysis of marginal tax rates are required to review 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 nominated within 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 considering incentive effects of taxation. It is even more complicated to know the marginal effective tax rate to apply to income from business and capital, since it may rely on factors such 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 signify the percentage of total income that is demanded in taxation. The pattern of average rates is the one that is important 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 provided for the taxpayer and dependents and because marginal tax rates are graduated; conversely, preferential treatment of income received fundamentally by high-income households can dampen these effects, producing regressivity, as shown by average tax rates that lower as income rises.
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