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 tax that places the same relative liability on all taxpayers—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 onus in relation to the rise in income, and a regressive tax is characterized by a less than proportional rise in the comparable liability. So, progressive taxes are viewed as fighting inequity in income distribution, while regressive taxes might increase these inequalities.
The taxes that are generally thought to be progressive include individual income taxes and estate taxes. Income taxes that are nominally progressive, however, could become less so in the upper-income categories—in particular if a taxpayer is able to lower his tax base by claiming deductions or by excluding particular income components from his taxable income. Proportional tax rates when applied to lower-income demographics could also be more progressive if such personal exemptions are claimed.
Income measured over the course of a given period may not definitely offer the most appropriate measure of taxpaying status. For example, transitory rises in income might be saved, and in temporary declines in income a taxpayer may select to pay for consumption by decreasing savings. Thus, if taxation is compared along with “permanent income,” it would be less regressive (or more progressive) than if it is held in comparison with annual income.
Sales taxes and excises (with the exception of those on luxuries) are generally regressive, because the share of personal income consumed or spent for a specific good lowers as the rate of personal income grows. Poll taxes (also termed head taxes), nominated as a fixed amount per capita, patently are regressive.
It is not easy to classify corporate income taxes and taxes on business as progressive, regressive, or proportionate, principally because of the 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 fundamentally on whether a national or a subnational (that is, provincial or state) tax is being debated.
In considering the economic purposes of taxation, it is important to distinguish between various concepts of tax rates. The statutory rates will be nominated in legislation; usually these are marginal rates, but occasionally they are average rates. Marginal income tax rates indicate the fraction of incremental income that is demanded by taxation when income is increased by one dollar. Ergo, if tax onus increases by 45 cents when income grows by one dollar, the marginal tax rate is 45 percent. Income tax legislature usually contain graduated marginal rates—i.e., rates that rise as income rises. Careful analysis of marginal tax rates must review provisions in addition to the formal statutory rate structure. If, for example, a particular tax credit (reduction in tax) lessens by 20 cents for each one-dollar growth in income, the marginal rate is 20 percentage points higher than specified in the statutory rates. Since marginal rates specify how after-tax income changes in response to changes in before-tax income, they are the important ones for considering incentive effects of taxation. It is even more complicated to nominate the marginal effective tax rate applied to income from business and capital, as it may depend on considerations 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 determine the part of total income that is demanded 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 grows with income. Average income tax rates generally grow with income, both because personal allowances are provided for the taxpayer and dependents and also due to that marginal tax rates are graduated; on the other hand, preferential treatment of income received for the most part by high-income households could swamp these effects, allowing regressivity, as indicated by average tax rates that decrease as income grows.
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